Could A Republican Sweep Hurt Stocks?

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Beware of the Elephants (Source: Birinyi Associates)

Markets, in general, like elections. And there is a long standing belief on Wall Street that Republicans are good for stocks. So the rising possibility that Republicans could win back majorities in the House of Representatives and possibly the Senate this November has whipped a number of market strategists into a frenzy. Says top strategist Ed Yardeni, “So what do stocks do just before and just after midterm elections and in the third year of the Presidential Cycle? They usually go up, and by quite a lot.” Deutsche Bank strategist Binky Chadha says the stock market has on average risen 13% in the six months after midterm elections, and 17% in the next twelve months. Chadha says the results of midterms on stocks are “eye-popping” (from Fortune):

With that in mind, many investors are gleefully awaiting this year’s midterm elections. The latest Cook Political Report projects that Republicans will gain control of the House and come close to winning back the Senate, pushing Congress into a state of political gridlock (according to Chadha, 70% of midterm elections result in the president losing seats in both chambers).
And gridlock, market experts say, is why midterm elections are good for stocks. The less power a president has, the less likely he is to push an activist agenda, unshackling businesses from the burden of regulatory uncertainty. Or so the theory goes.

This would be particularly welcome news at a time when the stock market has been been rather lackluster, if it were true. In fact, a closer look at the evidence suggests that a Republican win in November might not be as good for stocks as many strategists think. Here’s why:

Market research firm Birinyi Associates went back to 1945 to take a look at how the market reacted to different mid-term elections. What the market research firm found was that, yes, stocks do tend to rise in the months just before and right after midterm elections. But, surprise, surprise, what actually happens in the elections, not just the fact that they are held, does make a difference.

In general, Birinyi found that going back to 1962 stocks jumped nearly 10% in the two months before and three months after midterm elections. But in elections when there was a change in the majority in either the House or the Senate, the market did considerably worse. In the six midterms going back to 1945 where there was a switch in the party in power in Congress stocks rose just 6% in the five months around the election. What’s more, when the majority switched from Democrats to Republicans, the stock market did even worse. Take a look at the chart at the top of the post. When the donkeys became elephants, stocks tended to fall. The market lost 6% when Republicans took power during Truman’s presidency, and 4% when Republicans took over the majority in 2002. The Gringrich-lead 1994 Republican take-over of Washington produced a lackluster 3% stock market return.

So will this happen again? I think it might. A lot of strategists have been explaining past positive midterm results and why Republicans are a good thing for the market by saying that gridlock is good. Markets and companies perform best when Washington gets out of the way. And a do-nothing-Washington might be the best when the economy is good. But at a time when we have lackluster economic growth, and a ballooning budget deficit to deal with, we need all the help we can get, even if that help comes from Washington.

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