INVESTING: Stocks typically struggle during midterm election years

There is a “presidential cycle” for stocks, a pattern coinciding with various years of a presidency. In particular, year two of a presidency includes the midterm elections, with congressional seats contested in November. Historically, stocks have been weaker in year two than in years one, three and four of a presidential cycle.

We are at the halfway point of the midterm-election year of 2018, so it’s instructive to review past performance in similar years. While past performance is no guarantee of future results, studying historical patterns might give clues as to what to expect in the weeks and months ahead.

Sam Stovall, CFRA's chief equity strategist, notes that stocks are challenged in midterm-election years, possibly due to the uncertainty over the presidential party’s representation in Congress. Indeed, the party controlling the White House lost an average of 22 House seats and four Senate seats in the 18 midterm elections since 1946.

As shown in the table, the S&P 500 recorded the worst six-month stretch of the entire 16-quarter presidential cycle during the second and third quarter of year two, with average declines of 1.9 percent and 0.9 percent, respectively. Fortunately, the two worst quarters of the presidential cycle were followed by the three best.

According to Stovall, the midterm-election-year effect was even more pronounced for small-capitalization stocks. Since 1978, the Russell 2000 Index declined 2.5 percent and 6.7 percent, respectively, during the second and third quarters of midterm election years. Further, the average year-two loss—3.8 percent—was the worst yearly performance during the presidential cycle by far.

If historical patterns hold, stocks will tread water ahead of the Nov. 6 midterms, but better returns should be ahead.•

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Kim is Kirr Marbach & Co.’s chief operating officer and chief compliance officer. He can be reached at 812-376-9444 or mickey@kirrmar.com.