Economy and the Midterm Elections

We are a week away from the midterm elections and history shows us that the sitting President typically loses ~30 seats in the midterm elections. There is a relationship between the President’s approval rating and the number of seats his party loses. If history is a guide, President Trump (43% approval) may be in for major changes. Of all the Presidents since 1934, there are only two who had a worse approval rating leading up to the midterm election than Trump (i.e. Bush Jr in 2006 and Truman (1946 & 1950). We looked at historical midterms and what they may mean for the economy and markets.

Economy and Midterms. Since 1950, a U.S. President sees the best economic growth in the last year of his four-year term. However, when isolating GDP by quarter and looking at mid-term election years, we may be in for a disappointment in 4Q GDP. Historically, in the fourth quarter of a mid-term election year, the U.S. posts its slowest quarter of GDP of the four quarters in that year. Currently, the 4Q18 GDP estimate is 2.7%, higher than the historical 4Q average in mid-term election years (2.2%).

Will History Repeat Itself? Going back to 1935, the S&P 500 has been positive in the one year after every mid-term election except one (1938). On average, the S&P 500 rises ~16% in the one year after a mid-term election.  However, we are hesitant to use this historical data as a guide for what investors may expect over the next year. First, equities tend to be jittery in the one year before a mid-term election. This can be seen by the median average S&P 500 return one year leading up to historical midterm elections being ~2% and only positive 57% of the time.  However, in the one year prior to this year’s mid-term election, the S&P 500 has rallied ~5% (as of October 26, 2018). Therefore, it can be argued that some returns have been pulled forward from next year. Second, while equities have historically preferred a gridlock scenario (e.g. a split Congress) this scenario in such a divisive political environment would likely mean that Trump’s agenda (e.g. infrastructure, further tax reform) may be on hold. The first thing up is the debt ceiling (March 2019) and Democrats may use this to claw back Trump’s spending.

If history can tell us one thing, it is to expect the unexpected (e.g. Brexit). In addition, this presidency has been anything but traditional; therefore, investors need to try to ignore any headline news shocks and focus on long-term investment goals but expect higher volatility in the coming months.

Source: Data as of October 29, 2018.
Footnotes: Predicit, Verdence Capital Advisors.