Any uncertainty around monetary policy shifts were answered last week at the Federal Open Market Committee’s policy meeting. With that done, investor’s attention now pivots to Tuesday’s midterm elections. The outcome in the race for the house and senate will set a tone for any changes in the current legislative policy. But at the top of investor’s minds, undoubtedly, is how much could the outcomes of midterm elections impact capital markets?

In the near term, changes in the representation in the house and senate from each political party will remove any uncertainty constituents face on the legislative front. For markets, any uncertainty removed from investor’s landscape allows for a clearer forecast of the course we may run. Whether sentiment improves or declines due to changes in tax policy, spending policy, and other agenda items, history shows that market performance does not move in line with those policy shifts.

According to research conducted by U.S. Bank, the S&P 500 had below-average returns for all periods leading up to midterm elections and outperformed average returns in the 12 months after midterm elections (see table below). Does this mean you should use these findings as a trading strategy? Not so fast, this is just an average over the entire period. The paper explains that although average returns in the 12 months leading up to midterm elections have been below the historical average compared to non-midterm election years, they clarify that this under-performance gap has been closing.

Specifically, they compare the last twenty years, which has been a period of constant economic growth, with a low central bank interest rate policy, and tame inflation. Compared to midterms in the 60s and 70s, those same factors were not the case, and market underperformance was steeper. Although some underperformance tied to legislative uncertainty, they explain that the macroeconomic environment has a far greater influence on market returns than policy uncertainty or certainty.

With that said, the Federal Reserve has continued its path of more restrictive monetary policy and has hinted that they will stay the course until they can get this persistently high inflation to fall to levels which fit their stable price and employment targets. It is fair to say that there is still uncertainty ahead even after the midterms are over, which will likely leave us in a period of elevated volatility. Still, there is some good in the economy, with data showing a relatively healthy consumer and corporations reporting upbeat earnings. This all goes to show that although data may point to a specific outcome during midterm election years, the best thing to do is base it on fundamental data and not shift your investments on near-term uncertainty.

Jose Rendon, AIF®
Senior Portfolio Administrator

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