Stock-market returns in congressional mid-term election years tend to be the weakest of the four-year presidential cycle, but 2018 could prove even less impressive than in the past, according to Lori Calvasina, head of U.S. equity strategy at RBC Capital Markets.
The potential headwind has to do with a tight correlation between the stock market and Republican voter sentiment versus polls pointing to Democratic gains in November.
The S&P 500 is up more than 30% since Nov. 9, 2016. And since the 2016 election, which left Republicans in control of the White House and both houses of Congress, moves by the S&P 500 were 89% correlated with the Bloomberg Consumer Comfort Index reading for Republicans.
Republican sentiment came close to all-time highs in late January 2018, about the same time as the S&P 500 SPX, -0.12% set an all time high, “as the benefits of the tax reform bill became apparent in company guidance during 4Q17 reporting season,” Calvasina said, in a note.
A selloff sparked by inflation fears following strong wage growth in the January jobs report, turned into the first 10% correction in about two years, with the index hitting an intraday low of 2,531 on Feb. 8. The stock market recovered a big chunk of those losses, trading at 2,783 on Monday, about 3 percentage points below its record high.
But markets could easily test those lows depending which way the election wind blows, she said.
“If Republicans lose control of either the House or Senate (or seem likely to do so heading into the event), we think Republican sentiment would take a hit given its current lofty levels. The relationship between Republican sentiment and the S&P 500 of late tells us this would likely be a problem for stocks,” Calvasina wrote.
With a little under eight months to go before the elections, polls show that in the generic ballot, based on polls that ask people which party they would support in a congressional election, Republicans are behind, according to Nate Silver’s data-driven website FiveThirtyEight.
So, the takeaways are that, for one, investors should remember that returns in midterm election years tend to be low. Historically, the average S&P 500 return during mid-term year is 4%, while median return is 1%.
The second point is more somber: stocks have been following the fate of the Republican party, which doesn’t seem to be poised for victory if elections were held today.
Either way, lowering expectation for this year’s returns might be a good place to start.