A Strong Stock-Market Rally Could Be Coming Later This Year

May 06, 2022

It is extremely difficult to correctly time the stock market. However, the chances may be in your favor in 2022. Several historical trends are pointing to a significant rebound later this year.

One of these trends is midterm elections: the stock market in the United States tends to be very strong immediately following them. The market's conduct during midterm election years that occur during warfare and during Federal Reserve rate-hike cycles are two others.

You'll note that I didn't include the well-known "Sell in May and Go Away" seasonal trend, often known as the Halloween Indicator. According to the hypothesis, the stock market performs below-average during the six months from May Day to Halloween (the "summer" months) and above-average during the other half of the year (the "winter" months). However, a new study has revealed that this tendency only appears following midterm elections. There is no average difference in presidential election outcomes for the other three years of a presidential term.

Kam Fong Chan of the University of Western Australia and Terry Marsh of the University of California, Berkeley co-authored this research, "Asset Prices, Midterm Elections, and Political Uncertainty," which was published in the Journal of Financial Economics in July. They discovered, among other things, that annualized U.S. stock-market gains were 15.41 percentage points greater in the winter months after midterm elections than in all other months between 1871 and 2015.

According to academics, this big rally is the result of the resolution of the uncertainty that accompanies midterm elections, which tends to hold back the markets. Regardless of the cause, considering the stock market's recent difficulties, a large rebound gain would be especially welcome this year. The S&P 500 is presently down 11% from its all-time high set in early January. The Russell 2000 index, which is frequently considered a barometer for small and mid-cap firms, is down 20% from its November peak.

Midterm Elections in Times of War

Of course, each midterm year is unique, and this year looks to be no different. Could the stock-market impact of Russia's invasion of Ukraine overshadow stocks' post-midterm strength?

The academics sought to answer this question in an unpublished follow-up study. They began by focusing on midterm election years in the previous century, during which there were large global war conflicts. Because there were luckily a limited number of such years, any findings must be considered speculative. Nonetheless, they claim that the stock market's average return in such years was "remarkably consistent" with the trend they discovered in previous midterm years.

This conclusion shows, at the very least, that the Ukrainian war isn't a cause to expect post-midterm strength to be less prominent this year. And there might be a reason to anticipate it even more confidently because the controversy has slowed the market considerably more than typical before the midterm elections.

Midterm Exams During Rate-Raise Cycles

This midterm election year also coincides with the Federal Reserve's rate-hike cycle, which seems to be on track to run until the end of the year and into 2023. Because stock investors often respond unfavorably to increasing interest rates, might this cycle be one of the reasons why post-midterm gains do not materialize this year?

This was also investigated by Chan and Marsh. As with midterm elections during warfare, there have been very few midterm election years throughout rate-hike cycles. As a result, any findings must, once again, be considered speculative. Nonetheless, they discovered that, on average, after the elections, interest rates witnessed a "fairly durable drop."

What's the bottom line? If this were a "regular" year, the next 12 months would be the only period between now and 2025 when you should bet on the Halloween Indicator's wintertime strength. And while 2022 is far from a regular year, two of its most evident anomalies do not appear to be impediments to that wager.

If you're tempted to take advantage of a probable post-midterm surge, wait until the election results are in before putting your bets. That would probably be the morning of Nov. 9, the Wednesday after Election Day. However, if the results are so close that control of the House or Senate isn't yet assured, wait until it is.

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