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Here's the Impact of the Elections on Financial Markets

Republicans appear set to gain a small majority in the House, and control of the Senate is still up for grabs.
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After the Nov. 8 elections, it looks like Republicans will have a narrow majority in the House, and the Senate is a toss-up.

So what does that mean for financial markets? Nothing. That’s not completely true. With their majority in the House, Republicans can force a government-debt default or a government shutdown, which would be disastrous for markets.

But hopefully, cooler heads will prevail among the GOP. In any case, aside from wildcards like this, the direction of financial markets will be determined by fundamentals – economic, financial, and political developments – just like they always have been.

In the past, stock prices have appreciated after midterm elections. The average price return for the S&P 500 in the 12 months following midterm elections since 1950 is 15%. That does beat the annualized return of 13.2% for the entire period of 1950 through 2021. But not by a lot.

The changing structure of the stock market makes the data before 1990 of questionable value, Dave Sekera, chief U.S. market strategist for Morningstar, writes in a commentary.

Mid-Term History

And since then, fundamentals explain much of the weakness in stocks before midterm elections and much of stocks’ strength in the periods after them, he said. Sekera cited several examples.

In 2018, stocks started falling in September in response to interest-rate increases by the Federal Reserve. Sliding global economic growth also hurt. Then stocks rebounded in 2019, as the Fed reversed its monetary policy.

In 2014, energy stocks tumbled, as oil prices plunged due to increased production from fracking. “Economic growth slowed in the second half of the year, … [and] a flash-crash in the U.S. Treasury market further damaged market sentiment,” Sekera said. The market rebounded in 2015, as fundamentals improved.

In 2010, stocks were still suffering from the global financial crisis of 2007-09, Sekera said. “In the second half of the year, the economic rebound appeared to wane,” hurting stocks, he said.

“The Fed launched a second round of quantitative easing in November 2010, consisting of a $600 billion bond-buying program,” Sekera pointed out. And that helped equities recover in 2011.

Weak Stocks, Strong Yields

So what do the fundamentals say now? With inflation raging, interest rates soaring and economic growth slowing, the outlook isn’t too rosy for stocks. Some companies – such as technology giants Alphabet, Amazon, Apple, Meta Platforms, and Microsoft – already have registered weak earnings. And the trend is likely to broaden.

As the S&P 500 already has dropped 20% this year, bargains abound in the stock market, and they may get better.

Meanwhile, with inflation proving to be stubborn, the Fed is poised to raise interest rates further. Consumer prices surged 8.2% in the 12 months through September, and the Fed has lifted rates by 3.75 percentage points since March.

Further rate hikes should send short-term bond yields higher. Those yields already have become quite attractive for fixed-income investors holding bonds until maturity and should become more so. The one-year Treasury recently yielded 4.76%.