Impact of Mid-Term Elections on SP500 Since 1990

UBS research indicates that mid-term election years have “produced a tradable market bottom each time since 1914” that you can hold into the close of the following year. The flaw in UBS's mid-term election analysis is the arbitrary nature of knowing when and where the mid-term election year low can be found. Mid-term election year lows could occur in any one of 12 months and the mid-term year low can only be discerned with the benefit of hindsight. However, the central tendency for the stock market to be higher than the mid-term election year lows at the close of the following year is impressive. Thus far, theSP500 mid-term election low is the July 6 2010 low at 1003. The evidence from the UBS study suggests the SP500 will be higher than the 1003 “tradable bottom” on the close of Dec 31 2011. This report is simply going to review the “look-back” periods from 1990. Specifically, the focus will be on the two months before the Nov mid-term elections and two months after the Nov elections.

There is no discernible impact of the mid-term elections in 1990 simply because the US invasion of Iraq was the primary driver of the SP500 decline into Oct 11 1990. Following the Nov 6 1990 election day, there was a brief two day selloff in response to the election results, and from there, the SP500 recovered nicely into December 6 and April 17 1991. 1994 In 1990, the primary driver of the stock market was the Iraq invasion. In 1994, the primary driver of the stock market was the Peso Crisis and Monetary policy. These events kept the SP500 trading in a narrow 8%-10% trading range in 1994. In other words, and this is important, the elections have very little to do with the stock market. Much of the statistical analysis surrounding the presidential cycle is misleading. Yes, there is some merit to the presidential cycle, but it is really tied to events exogenous to the elections themselves.

Note in 1994, there was a one day rally following the Tuesday Nov 8 1994 election. But the Fed was still tightening interest rates in Nov 1994. It wasn't until after the Fed finished hiking rates in Jan 1995 that the SP500 started to rally in earnest. Until then, the SP500 was held hostage by Fed policy. 1998 In 1998, the primary driver of the SP500 was the LTCM crisis. Like 1990, it set a cycle high in July, followed by a 20%+ correction precipitated by a crisis. The mid-term election low set in Oct 1998 had nothing to do with the mid-term elections and everything to do with the resolution of the LTCM default and Fed rate cut on Oct 14 1998.

2002 The primary of the stock market plunge in 2002 had nothing to do with mid-term elections and everything to do with the exposure of widespread corporate misbehaviors and accounting frauds. That is what held the SP500 into Oct 10 2002. And it was the US preparation for another war with Iraq that hamstrung the SP500 into Mar 12 2003. Sure, there was a short term twitch in Nov 2002. The stock market rallied into Wednesday Nov 6 2002 the day after the Nov 5 2002 elections and then corrected for a week into Wednesday Nov 13 before resuming a rally into Dec 2 and declining into March 2003. The risks to the stock market in 2002, like in all the other mid-term election years since 1990 had nothing to do whatsoever with the elections themselves. Seen from this vantage point, elections are almost completely irrelevant factors on stock market behavior.

2006 In June 2006, the Fed stopped hiking rates. When investors realized the Fed had no intent on killing the economy with ever-increasing restrictive rates, the stock market took off to the upside in July and August. Oh sure, there was a statistically insignificant pause from Oct 23 into Monday Nov 3 2006. But, the market began rallying again on Election Day, Tuesday Nov 4. The SP500 did not even look back until a little “petit mort” in the credit markets in late Feb 2007.

2010 The risks to the stock market in 2010 have been related to sovereign defaults and double dip scenarios. These risks prompted a 17% decline into July 2010. Presumably these risks are fading into the background as the stock market approaches year end. Will the stock market be affected by the November election results in a statistically significant manner? There is not a chance in the world there will be a statistically significant correlation to the mid-term November elections themselves. The stock market will positively correlate to the bullish or bearish news that macro-risks are increasing or decreasing. C'est tout! Now, what does concern me a bit, and what should concern investors is the ABC look to the rally off the July low. Recall that the drops in 1990 and 1998 occurred from July highs and bottomed between Oct 8 and Oct 11. Consider also, that the 2002 low occurred on October 10 and that the 2007 high occurred on October 11 as it entered the earnings season. A high that sets in the first half of October, could be a secondary high that fails to breach the 2010 year high. A failure to breach to 2010 high in Q4 implies a retest of the year low will be in order, not unlike what happened in 1994, when Fed policy held the SP500 hostage into December 1994. Stay tuned for the rest of the story…But rest assured it will nothing to do with the misleading election cycle crap.