Investor Preparation for the U.S. Midterm Elections

Marc Zabicki (00:00):

If you follow cable news over the coming weeks, it will be nearly impossible to avoid the midterm elections. Every new poll, campaign proposal, and prediction about the control of Congress will be accompanied by a confident forecast about what it means for political outcomes. In this latest edition of LPL Street View, we want to put the election into a market perspective, discuss how tactical investors might approach the likely volatility surrounding election season, and consider which industries could benefit or struggle if Democrats gain control of Congress. For starters, midterm election years have historically been more volatile than other years. Since 1970, the median standard deviation of stock returns during midterm years has been nearly 16%, compared with approximately 13% in all other years. The volatility has also tended to be concentrated in the months immediately preceding election day, when uncertainty about taxes, regulation, spending, and congressional control is at its highest.

Marc Zabicki (01:13):

That uncertainty has often weighed on market returns. Since 1931, the S&P 500 index has produced an average price return of 4.7% during midterm election years, compared with 9.5% in all other years. While volatility can be at its highest in the weeks leading up to election day, history shows that the market can indeed begin to rally in the days just ahead of the election. To put that into perspective, since 1970, the S&P 500 index has generated a 14.1% average return in the six months immediately following the midterm elections. The important catalyst may not have been which party won or lost. The catalyst for that performance was that post-election uncertainty declined and investors gained greater clarity about the policy environment. So, what should a tactical investor consider? First, prepare for volatility without automatically treating it as a signal to abandon risk. A tactical approach could involve maintaining rebalancing flexibility, preserving some liquidity, and identifying fundamentally attractive assets that may become temporarily dislocated.

Marc Zabicki (02:37):

It should not mean moving an entire portfolio in response to every poll or election news item. If Democrats capture meaningful control of the legislative agenda as they are expected to do, healthcare affordability, Medicaid funding, Affordable Care Act subsidies, tariff authority, and oversight of the administration are all likely to receive greater attention. Democratic congressional leaders have identified reversing Medicaid reductions and extending Affordable Care Act tax credits as central priorities. Potential beneficiaries could include hospitals, managed care providers with significant Medicaid or exchange exposure, selected clean energy businesses, and companies that rely heavily on imported components if indeed Congress succeeds in restraining tariffs. Likewise, renewable energy developers and grid modernization companies could benefit from greater policy support, while traditional energy producers could indeed face more oversight. Large technology companies, artificial intelligence infrastructure providers, and utilities supporting data centers could also counter greater scrutiny over competition, electricity demand, consumer costs, and data center expansion, and look for AI companies to increasingly become a political issue.

Marc Zabicki (04:12):

These are some reasonable areas for a tactical watch list. However, they are not reasons to bet the farm. Election-based investing requires an investor to be correct three times, correctly forecasting the election, correctly forecasting the resulting policy, and then correctly forecasting the market's reaction. Even if your first call is right, the next two may not be. In fact, history indicates that investing based on political outcomes is not a good strategy at all. Keep that in mind. Tactical investors should respect election volatility, monitor policy sensitive industries, and use market dislocations selectively. But know this, corporate earnings, economic growth, interest rates, inflation, and capital investment are likely to remain more important than the final seat count in Congress. Thanks for listening, and as always, allocate wisely.