Favorable Mid-Term Election Seasonality

One of the most persistent seasonality “edges” over the last sixty years has been the short to intermediate term outperformance of the stock market after the mid-term elections. If you just look at annual calendar year returns, the best returns have occurred in the pre-election year, which for this election cycle would be 2011. Since 1933, the Dow Jones Industrial Average with dividends included has been up every pre-election year with an average return of 17% per year.

But the outperformance actually begins earlier. Schwab cited analysis by Ned Davis Research from 1929-2009 that showed the best performing quarter of the election cycle is the 4th quarter of the mid-term election year, which starts next week.

It certainly seems like the presidential election cycle affects stock market returns. I believe that politics plays a large role here. The mid-term elections often result in changes in Congress and greatly affects the White House. Incumbents who have devoted the first half of the election cycle to social/economic changes are now focussed more on getting re-elected. Suddenly, big spenders in both parties become more fiscally responsible, and pledge to cut the deficit and balance the budget. Legislation friendly to business is introduced. The Federal Reserve cooperates by pumping up the economy with easy money and low interest rates.

I did a quick analysis using month-end data where I combined the favorable period after mid-year elections with the Sell in May rule. The buy occurs the last day of October prior to the mid-term election. The sell occurs seven months later at the end of May. Here is the data using the S&P 500 which actually understates the return because dividend returns are omitted:

  S&P 500 Mid-Term election: Seven Months after Election
             
    End Oct End May      
  1950 19.53 21.52 10.19%    
  1954 31.68 37.91 19.67%    
  1958 51.33 58.68 14.32%    
  1962 56.52 70.80 25.27%    
  1966 80.20 89.08 11.07%    
  1970 83.25 99.63 19.68%    
  1974 73.90 91.15 23.34%    
  1978 93.15 99.08 6.37%    
  1982 133.72 162.39 21.44%    
  1986 243.98 290.10 18.90%    
  1990 304.00 389.93 28.27%    
  1994 472.35 533.40 12.92%    
  1998 1098.67 1301.84 18.49%    
  2002 885.76 963.59 8.79%    
  2006 1377.94 1530.62 11.08%    
       Average 16.65%    

Every year since 1950 had a positive return with an average return of 16.65% over the seven months! I also looked at some earlier data using the Dow Jones Industrial Average.

  Dow Jones        
    End Oct End May      
  1930 183.35 128.46 -29.94%    
  1934 93.36 110.64 18.51%    
  1938 151.73 138.18 -8.93%    
  1942 113.5 141.18 24.39%    
  1946 169.15 169.25 0.06%    

In 1946, the return was only marginally positive (0.06%), and there were losses in 1930 and 1938.

Caveat: Given the losses in the depression years, it is possible that the normally strong seasonality may falter over the next nine months if the economy weakens again. But the odds are we will have another positive return for the seven month period.

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