Why Stocks Are Poised for 12-Month Rally

An oft-repeated maxim is that the stock market hates uncertainty, and a major cause for uncertainty has been resolved, given that the U.S. midterm congressional elections are now behind us. If history is a guide, investors should expect the S&P 500 Index (SPX) to advance over the next 12 months, per analysis by Yardeni Research Inc., as cited by Barron's. 

In Tuesday's midterm vote, returns indicate that the Democrats won a majority in the House while the Republicans held their majority in the Senate. But the Yardeni Reseach study—and other studies—show that stocks have risen in the 12 months after every midterm election from 1954 through 2014, a span of six decades, without exception, and regardless of which party posted gains. This has happened regardless of the immediate short-term reaction of the market after the election.

Why Stocks May Rally

Source: Yardeni Research Inc., as reported by Barron's

Significance for Investors

As noted above, the market has a long history of reacting negatively to uncertainty, and positively to the resolution of uncertainty. It also has a tendency to react negatively in the short term when expectations are confounded. A prime recent example related to elections was the surprise win of Donald Trump in the 2016 U.S. presidential election. Although Trump was widely viewed as considerably more business-friendly than opponent Hillary Clinton, the market nosedived in overnight trading after his unexpected win became apparent, before reversing course within hours and commencing a long rally that extended into January 2018. Stock market gains so far since Trump's election are detailed in the table below.

The Stock Market Under Trump

Source: Yahoo Finance; gains computed between the Election Day closes on Nov. 8, 2016 and Nov. 6, 2018.

Barron's notes, however, that Yardeni's findings regarding the aftermath of midterm elections actually may have more to do with the four-year presidential election cycle, based on a study by LPL Financial that uses data from 1896 onwards. LPL discovered that, historically, the best 9-month period for the Dow Jones Industrial Average covers the fourth quarter of the second year of a presidential term and the first two quarters of the third year. The average gains for those three quarters, LPL calculates, have been 4%, 5.2% and 3.6%, respectively.

Right now we are in the fourth quarter of Trump's second year in office. LPL theorizes that these stock market gains result from the president's pursuit of expansionary economic policies ahead of the elections in the fourth years of their terms. At those times, they either are seeking re-election, if in their first terms, and are hoping to boost the chances of successors from their own party, if in their second terms.

Looking Ahead

One current fundamental factor that may break the historical pattern found by Yardeni is Trump's escalating tariff war with China. This has been the major focus of the equity markets around the world, with reports of rising tensions sparking selloffs and indications of possible agreements prompting rallies, per another Barron's story.

Looking back at history, the Smoot-Hawley Tariff Act, signed into law on June 17, 1930, is widely viewed as a key catalyst for the worldwide Great Depression of the 1930s. From April 10, 1930 to June 1, 1932, the S&P 500 plummeted by 83%, according to calculations by Yardeni. Midterm elections were held in 1930, but they did not figure in Yardeni's analysis of post-midterm stock market performance, which started with the 1954 elections.