- The 2022 U.S. midterm elections will determine the course of the legislative agenda over the next two years.
- We review how elections have driven volatility in the market, as well as what impact past midterm elections had on the performance of U.S. equity markets, factors and sectors.
- Economic uncertainty has played into the superior relative performance of defensive strategies (such as minimum volatility and high dividend yield) year-to-date. Elections are just one factor to consider.
Leading up to and including Nov. 8, Americans will vote for 35 Senate and all 435 of the voting House seats. If Democrats retain a majority in both chambers of the Congress, President Joe Biden may be able to push through his policy agenda with less opposition, but if Republicans prevail, there could be political gridlock. What may be the implications for investors?
Elections from a historical context
A few specific questions arise:
- Have elections been consequential to the performance of U.S. equity markets?
- Can history be any guide as investors position their portfolios as we approach election day?
In short, we found that elections generally brought volatility to the market (as shown below). Novembers with presidential elections had higher cross-sectional volatility than Novembers with midterm elections, which was greater than all non-election Novembers or all other months on average since 1975.1 Diving further into midterm elections, volatility was found to quickly drop in the three months following elections.
Elections and US equity-market volatility
A focus on midterms
Next, we studied 11 midterm-election outcomes since 1978 and their impact on the performance of broader U.S. equity market, style factors and sectors across two election-outcome scenarios:
- Status quo: No change in House or Senate majority (five occurrences)
- Flip in control: Change in majority in either or both chambers of Congress (six occurrences)
Our research takes a unidimensional view on how election outcomes have impacted historical-market performance and does not account for other key market forces that were in play. Historically, the broader U.S. equity market has, on average, reacted positively to the reigning political party's ability to retain its position in both chambers of Congress. Interestingly, a flip in control hasn't meant a drawdown relative to the price performance observed prior to the election. We compared pre- and post-election performance to minimize the impact of other externalities such as macro-economic environment, which may also be driving the performance of equity markets (shown below).
US equity market performance following midterms
Based on gross USD performance of the MSCI USA Index from 1978.
One way the two election outcomes are different is in how they feed into market certainty and uncertainty. The status quo generally translates into continued stability of the policy and economic roadmap with the reigning political party maintaining similar levels of control in terms of achieving its mandate. However, a flip in control has led to uncertainty around the ability of the president's party to pass bills and influence regulations, leading to enhanced volatility on a relative basis. This certainty, or the lack of it, has historically impacted performance of style factors and sectors.
In general, defensive style factors (yield, low volatility and quality) and defensive sectors (energy, consumer staples and utilities) saw deteriorating active performance, and cyclical sectors (information technology) generally benefited after elections. This likely resulted, in part, from investors unwinding their defensive trades they had implemented to hedge volatility going into the elections. A status-quo scenario meant sharper loss in active performance of defensive strategies, likely driven, in part, by greater clarity around the legislative roadmap. In contrast, a flip in control caused more muted changes to active performance of style factors and sectors.
Midterm style-factor performance
Midterm sector performance
Based on gross USD performance of MSCI USA Factor and Sector Indexes relative to MSCI USA Index from 1978.
An awareness of market conditions
As mentioned above, election outcomes are just one part of the larger market environment driving equity performance. Going into this year’s mid-term elections, for example, the market continues to face challenges of fearful inflation, looming recession, aggressive Fed tightening, energy crises and a strengthening U.S. dollar. These uncertainties have played into the superior performance of defensive strategies (such as minimum volatility and high dividend yield) year-to-date. How and when these uncertainties get resolved will be an additional guide to investors as they position their portfolios for Election Day and beyond.
1Cross-sectional volatility (CSV) measures dispersion in stock returns over a given period. CSV was calculated using Barra US Total Market Equity Deep History Model.