Democrats and Republicans may both have something to celebrate in the months following the midterm elections: A stock market rally. From 1922 to 2006, the average gain of the Dow Jones Industrial Average over the 90 trading days following midterms (roughly November until mid-March) was 8.5 percent, according to a new study authored by Brian Gendreau, market strategist for Financial Network. That's almost 5 percent higher than the Dow's gains in non-election years.
Historically, the post-election period has been a good one for stocks. "So the question is, 'Did the markets go up in the midterm election years by more than average in non-election years?' Gendreau says. "And the answer is, 'Yes, by a huge amount more.'" The Dow has risen following 19 of the last 22 midterm elections.
In the weeks before midterms, the market generally tends to perform well. "The market starts to go up beforehand and it just doesn't stop," he says. And generally, the party of the president tends to do poorly in midterm elections. (Since 1942, the party in control of the White House has lost an average of 28 seats in the House and four in the Senate.) During that period, the only time the ruling party gained seats in both the House and Senate was in the 2002 elections, and the market fell afterward—making it the only time the Dow has fallen after a midterm election since 1942.
Since the midterms tend to be an equalizing force on Capitol Hill, many experts have said in the past that this proves the markets like gridlock in Congress. Gendreau offers a different explanation: The markets hate uncertainty. "Before the mid-term election there's a lot of uncertainty, and often one party swept in a lot of seats along with the presidential election and that gets reversed to some extent," Gendreau says. "Then everyone knows what the playing field is and has a better idea of what might happen going forward."
Also, after the midterms, there is generally a more balanced share of power between the president and Congress, so the chance for compromise is more likely. "The market seems to like that," he says.
So what about this year? Gendreau is the first to admit that he's not the first economist to release a survey like this. His research just covers a longer period of time. He also notes that given the ever-increasing wealth of information available to traders today, the effects of this trend may be somewhat weaker going forward. But so far this year, the Dow has been steadily rising in anticipation of the midterms, gaining about 7 percent year-to-date.
Looking further out, the year following the midterms or the president's third year in office is usually the best year for the Dow, according to an older study by Gendreau. From 1871 to 2005, the average return of the S&P Composite Stock Index during the third year of a president's term was 10.1 percent. During the fourth year in office the index was up 7.5 percent, on average—a marked improvement over average returns in the first year (3 percent), and the second (2.7 percent).