Now that the midterm elections are safely behind us, a lot of people are wondering how politics will impact their investment returns. The conventional wisdom is that divided government–where one party holds the White House while the other controls the House, the Senate or both–is good for the markets. But is that true?
The truth is, there is no magic formula. The specific circumstances of each era, and the actions taken by each President and Congress, are much too individual and different for us to generalize. But the statistics are interesting nonetheless. Perhaps most interesting of all, the markets seem to like midterm elections regardless of who wins. The S&P 500 has gained in every six-month period following the last 16 midterm elections, with a remarkable average return of 16%. Going back a little further, from 1922 to 2006, the Dow Jones Industrial Average has jumped 8.5% in the 90 trading days following the midterms, versus just 3.6% in non-midterm-election years.
If you look at divided government vs. times when one party controlled both the White House and Congress, the results are a bit harder to interpret. The average annual total return for the S&P 500 when Washington is a one-party town has been 9.4%, compared with 10.6% when the parties were checking and balancing each other. However, another study going back to 1900 found that during times of total unity (67 of the 111 years analyzed), the Dow gained 7.6% a year. When Washington is locked in partial gridlock, in other words, where one party controlled Congress and the other the White House, (32 years in all), the index gained 6.8%. And during the 12 years of a gridlocked Congress, the S&P gained just 2% per year.
Since 1945, the pattern holds. Under total unity, stocks climbed at a 10.7% annual pace. Under partial gridlock, they gained 7.6% per year. And under total gridlock, which accounts for eight of the 65 years, they gained just 3.5% per year.
This gloomy news might be offset by another trend, however. Since 1900, the third year of a US presidency has been easily the best year for markets, with investors enjoying median annual gains of 16.5%.
There’s one other statistic to note, which might trump them all. It appears that the Standard & Poor’s 500 Index performs two or three times better when Congress is out of session than when at least one of the two chambers is at work. A famous quote from an 1866 New York court decision, that “No one’s life, liberty or property are safe while the legislature is in session,” would seem to have some truth for the equity markets.