With the summer over, America’s focus is shifting toward the second half of a complicated year. Investors have witnessed the lingering effects of the pandemic, coupled with rising interest rates and Russia’s invasion of Ukraine. All three of these events have posed significant consequences for markets across multiple sectors. Now, another important catalyst is quickly drawing closer: The 2022 midterm elections.
Midterms are not an economic event. But they do have a long history of negatively impacting financial markets in the months leading up to election day. In fact, as The New York Times reports, they are often the weakest economic months of a presidential term. So, with the midterms now in sight, investors are bracing for market history to repeat itself. The recent plunges we’ve seen from the S&P 500 and Nasdaq Composite are only in keeping with this trend.
According to CD Wealth Management, “Since 1962, in the 12 months prior to a midterm election, the average annual return of the S&P 500 is 0.3%, well below the historical average of 8.1%.” Taking precautions to avoid midterm-induced losses is nothing new for investors. But this year poses new complications due to some unprecedented macroeconomic headwinds. That poses a question: How can investors stay ahead of the curve before midterms as Wall Street prepares for further turbulence?
Why the 2022 Midterm Elections May Be Different
To answer that, we actually have to ask a few different questions. But the first thing to ask as 2022 midterm elections near is whether a certain party is better for the market.
According to The New York Times, the answer may be yes. Citing Ned Davis Research, NYT reports that “from 1901 through February […] and adjusted for inflation, the Dow returned 3.8 percent annualized under Democratic presidents, versus 1.4 percent under Republicans.” The outlet lays out even more promising statistics for investors:
“Based on the historical data, the best political alignment for the stock market is one that could arise this November if the Democratic Party has a major setback. Since 1901, a Democratic president combined with Republican control of both houses of Congress has produced annualized real stock returns of 8 percent, using the Dow.”
Given forecasts that Republicans will take back the House in November, that prediction should offer investors some hope. History also shows a pattern of markets rebounding in the months following midterms. According to Charles Schwab, “In 17 of the 19 midterms since 1946, the market performed better in the six months following an election than it did in the six months leading up to it.”
This trend is driven in part by the expectation that a newly flipped Congress will increase government spending, thereby stimulating the market. But as Charles Schwab Chief Investment Strategist Liz Ann Sonders notes, this year’s macroeconomic forces may complicate things.
Sonders isn’t the only expert who feels this way. In an email, Tradier CEO Dan Raju recently spoke to InvestorPlace about why the 2022 midterm elections may yield different results. The evidence that he has seen makes it clear retail investors are focused on “inflation, recession, and volatile markets.” Raju continues:
“These are important concerns that retail investors must pay close attention to. What is important for retail investors to realize is that they are living in times where past rationalizations of looking at these concerns and their impact on their investments don’t apply or apply differently.”
What to Watch For
So, if this is true, another question must be asked: What important trends should investors watch for following the 2022 midterm elections? According to experts, the elections will lead to a few outcomes that may benefit certain sectors.
First, the likely “red wave” will probably lead to partisan gridlock. Michael Wang, veteran fund manager and CEO of Prometheus, thinks this scenario would ultimately help markets. In an email to InvestorPlace, he says that gridlock is generally “good for stocks, but particularly good for companies exposed to the top 1%.” Wang cites LVMH Moët Hennessy Louis Vuitton (OTCMKTS:LVMUY) and Interactive Brokers Group (NASDAQ:IBKR) as two examples.
As Wang notes, companies catering to high-income clients would benefit from gridlock because it would stop income and capital gains taxes from increasing. Additionally, a Republican House would also likely mean minimum wage is not raised, benefitting companies like McDonald’s (NYSE:MCD).
Another factor investors should consider is the possibility of decreased government spending. A Republican victory would make it much harder for Democrats to pass legislative spending packages. “The midterms will limit increases in federal spending, putting a damper on the Democrat’s Build Back Better plan,” says Wang. “This means we’ll see less inflationary pressure which will be good for markets.”
Steve Massocca, Managing Director of WedBush Securities, recently spoke to InvestorPlace as well, highlighting the benefits of government gridlock. He sees the energy sector having significant growth potential in the coming year:
“One clear beneficiary of a change in Government, is the Energy industry, specifically those enterprises providing fossil fuels. Already benefiting from a dearth of energy (largely driven by the war in Ukraine), this industry will be perceived to benefit from a Republican victory.”
That said, Massocca does add that the next election following midterms will pose more significant effects. The Wedbush director says the market will be “more reactive” to the 2024 presidential election.
What Comes Next?
If these predictions are correct, it’s clear investors can expect more volatility within the coming months. However, Massocca’s point is also well taken; the energy sector will likely benefit from a Republican victory. That means stocks with ties to the fossil fuel industry will shoot up after midterms, including industry leaders like Exxon Mobil (NYSE:XOM) and Diamondback Energy (NASDAQ:FANG).
Still, markets are clearly facing some extreme uncertainty as the U.S. prepares for 2022 midterm elections. With interest rates still rising, it may be best to consider the stocks that hold up well in difficult economic landscapes. That includes leaders in consumer staples such as Procter & Gamble (NYSE:PG) and Walmart (NYSE:WMT).
Finally, investors should pay special attention to the tech and retail spaces. According to Dan Raju, “a sweep by either side [Republicans or Democrats] will indicate a sense of stability that will benefit the tech, financial and retail sectors.”
On the date of publication, Samuel O’Brient did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.