Synchronizing the stock market successfully is very difficult to achieve. However, the odds may be in your favor in 2022. Several historical patterns are converging to suggest that the market will rebound strongly later this year.
One such pattern centers around midterm elections: the US stock market tends to be particularly strong immediately after them. Two others are market behavior during wartime midterm election years and during Federal Reserve rate hike cycles.
You’ll notice I didn’t mention the famous “Sell in May and Go” seasonal pattern, which is also known as the Halloween Indicator. The theory is that the stock market performs below average in the six months from May Day to Halloween (the “summer” months) and performs above average the other half of the year (the “summer” months). “winter”). But recent research has shown that this pattern plays out only in the periods after midterm elections. In the other three years of a presidential term, there is no average difference in returns during summers and winters.
This report, titled “Asset Prices, Midterm Elections, and Political Uncertainty,” was published last July in the Journal of Financial Economics by Kam Fong Chan of the University of Western Australia and Terry Marsh of the University of California, Berkeley. Among other revelations, they found that, between 1871 and 2015, annualized US stock market returns were 15.41 percentage points higher in the winter months following the midterms than during all other months.
Professors theorize that this sharp rally is caused by the resolution of uncertainty preceding the midterm elections, which tends to hold markets back. Regardless of the reason, a strong bullish gain would be especially welcome this year, given the recent weakness in the stock market. The S&P 500 is currently 11% below its all-time high from early January. The Russell 2000 Index, a widely used gauge for small- and mid-cap stocks, is down 20% from its November high.
Midterm exams in wartime
Every midterm year is unique, of course, and this year promises to be no exception. Could the stock market shock from the Russian invasion of Ukraine swamp the stock trend toward post-medium term strength?
In unpublished follow-up research, teachers attempted to answer this question. They first focused on the mid-election years of the last century when there were major global military hostilities. Because there were, thankfully, a relatively small number of such years, any conclusions must be tentative. However, they report that the average stock market performance in those years was “remarkably consistent” with the pattern they found in other intervening years.
At a minimum, this result suggests that the Ukrainian conflict is not a reason to expect the post-midterm strength to be less pronounced this year. And it could be a reason to predict even more confidently that it will happen, since the conflict has slowed the market even more than is usually the case before the midterm elections.
Partial terms during rate increase cycles
This midterm election year also coincides with the Fed’s rate-hike cycle, which looks poised to last through the end of this year and into 2023. Because stock investors typically react negatively to rising interest rates , could this cycle be a reason why post-midterm strength might not materialize this year?
Chan and Marsh also explored this question. As was the case with midterm elections during the war, there have been relatively few years of midterm elections that occurred during rate increase cycles. So, once again, any conclusion must remain tentative. Still, they found that, on average over those years, interest rates experienced a “reasonably persistent decline” after the election.
The bottom line? If this were a “normal” year, the next 12 months would be the only time between now and 2025 when you should bet on the strength of winter heralded by the Halloween Indicator. And while 2022 is by no means a normal year, two of its most obvious abnormalities don’t seem to stand in the way of that gamble.
If you’re tempted to exploit a potential post-midterm rally, wait until after the election results are in before placing your bets. Presumably, that would be the morning of November 9, the Wednesday after Election Day. But if the results are so close that control of the House or Senate still isn’t secure, wait until it is.
Mark Hulbert is a regular contributor to Barron’s. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at email@example.com.
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