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In the words regulators have our industry print on the tin, ‘past gains are no guarantee of future performance’. Yet even through the dark days of Black Monday in the mid-80s, or the inflation bust of the late 70s, one statistic has held remarkably true for the US stock market over the past 80 years: the index has seen gains after midterm elections. 

Placed two years into each presidency, the Congressional votes tend to deliver protests against the current occupant of the White House, and the result is often a division of power in the two main legislating arms of the US constitutional apparatus. This, goes the argument, means fewer government policy initiatives to upset the status quo, and markets and businesses can enjoy the certainty that results. As the chart below shows, the 12 months following a US midterm election have not delivered a negative performance for the S&P 500 since the aftermath of the Great Depression. 

It has sometimes been touch and go. The period after the end of World War II looks anaemic, for obvious reasons; similarly, in the past decade it took huge, repeated injections of central bank and government capital to deliver small percentage gains. 

However, the logic will face a rigorous test this time round, because much of the capacity other eras have enjoyed for monetary or fiscal support of growth is absent as US and global markets face a polycrisis of political, strategic, and economic challenges.  

Many of the peaks on our chart stem from the peculiar circumstances of the time. In 1974, the period caught the removal of the oil embargo and a resulting market rally; in the 1980s, Ronald Reagan’s third year in office coincided with the first cuts in interest rates after years of brutal action to curb inflation. 

This time round, the US economy heads into 2023 under a level of pressure unseen in more than a decade. China is still partially closed and has been enduring a property slump. Prices of both the staple and discretionary goods that consumers buy have jumped and are still rising. The war in Ukraine is creating enormous headwinds for the European economy and there are hints of a new Cold War. 

All of this alone should add up to a retreat after the global economy’s bounce back from Covid, but to that we have to add the actions of the Federal Reserve and other central banks, determined at last to pull back the huge flood of capital they have pumped into the financial system since 2009, as they tackle inflation. 

We, and others in the financial world, have been calling for the Fed to slow down - or “blink” - judging that all of these factors may tighten the financial screws enough to cause turbulence that could hark back to 2008. The spasms in UK markets after Kwasi Kwarteng’s budget may be just the first such hiccup globally. 

There is also little prospect of further fiscal support for the economy. A Republican Congress sought to pressure President Obama in 2011 and 2013 by refusing to raise the ceiling on the United States’ gigantic public debt. We are nearing the ceiling again, and next year is likely to see more brinkmanship, and more restraint on public spending, not less. 

Growth and consumer spending in the United States have borne up extraordinarily well. But the economy faces the real risk of recession next year. The writing is on the wall. Consumers and businesses are starting to eat into their savings. Warning signs are flashing from the housing market on affordability and sales. 

The result should be sharper cuts in valuations of listed companies, private companies, and other assets as earnings decline and we worry this could lead to a further correction in the stock market. The S&P has been in formal bear territory since June but has still only handed back under a fifth of the past 14 years’ five-fold rise in value. 

And yet… It can be dangerous to discard the historical evidence. 

Over those 80 years, the average return from the New York market for the 12 months following mid-terms has been a remarkable 15 per cent, more than twice the annual average we expect from the index over the next 10 years. In times where a Democratic president faces a Republican Congress, that number is even higher. But, who knows, if the past three years have taught us anything at all, it is that circumstances change – the regulators are right to caution. 

* This article was first published in The Sunday Times on Nov 13, 2022

Andrew McCaffery

Andrew McCaffery

Global CIO, Asset Management