US stock market prepares for mid-term poll results – and a bonanza in 2023?

AJ Bell press comment – 8 November 2022

• Mid-term election results will usher in third year of Biden Presidency
• Third year of a Presidency is, on average, the best year for US equities
• Dow Jones has fallen just once in the third calendar year of a US Presidency since 1948

“Since World War II the US stock market has done best, on average, in the third year of a Presidential term and, as they await the results of the mid-term elections, that means investors will already be looking ahead to 2023,” says AJ Bell investment director Russ Mould. “Even though the past is no guarantee for the future, holders of US equities will be hoping that the combination of a policy pause or pivot by the US Federal Reserve, economic pump priming by the White House ahead of November 2024’s Presidential poll and 2022’s hefty falls in headline indices provides the foundations for juicy gains next year.

“By calendar year, the Dow Jones has risen by an average of 16.2% in the third year of a Presidential team across eighteen Presidencies going back to Harry S. Truman in 1948-1951.

“This compares to the average single-digit percentage gains generated during the first, second and fourth and final years of a Presidency.

“The only year when the 30-stock Dow actually fell during the third year of a Presidency was in 2015, during Barack Obama’s second stint in the White House.

Source: Refinitiv data. Capital returns in dollars. Covers period from Harry S. Truman (1948-1951) to first two years of Joseph R. Biden (2021 to 2022 to date).

“The theory seems to be the incumbent President starts to pull out all of the economic stops and get the economy firing on all cylinders before they go for a second term, or at least try to lay the foundations for their successor’s campaign for the White House.

“There is currently much angst amongst President Biden’s supporters that they will lose their narrow majority in the lower House of Representatives and face Republican control of both the House and the Senate, a scenario which could in theory hobble any legislative programme that the Democrats have in mind.

“However, history does not suggest that such an impasse is seen as a negative outcome by investors in US equities – quite the opposite. Four of the six best third years for capital returns from the Dow came when the President, in the form of Richard Nixon, Bill Clinton (twice), Dwight Eisenhower and George WH Bush, had to confront both a House of Representatives and a Senate that were under control of the opposition party. Indeed, financial markets may welcome such checks and balances, in the view that any rash or egregiously foolish policies will be blocked by a logjam on Capitol Hill.

Source: Refinitiv data. * John F. Kennedy assassinated in November 1963 and replaced by Lyndon B. Johnson. ** Richard M. Nixon resigned in August 1974 and replaced by Gerald R. Ford.

“All of this said, politics alone is unlikely to shape the fortunes of the Dow Jones and America’s other leading equity indices, as the backdrop to the best (and worst) returns from the third year of a Presidency suggests.

“The 1975 bonanza under Nixon’s successor, Gerald Ford, came after the market collapse of 1973-74, while the surge under Bill Clinton in 1995 followed the Greenspan interest rates shock and mid-cycle growth pause of 1994. In 2003 under George H.W. Bush, the US was emerging from the wreckage of the technology bubble bust of 2000-2002, while in 1999 that bubble was expanding rapidly during the final half of Clinton’s second stint in office.

“On the downside, Jimmy Carter’s third year was dogged by a fresh oil shock and another surge in inflation after the fall of the Shah of Iran, while the Black Monday Crash of 1987 took the wind out of the sails of Ronald Reagan’s second term, at least so far as investors were concerned.

“US stocks also fell for the only time during a third year of a Presidency under Barack Obama in 2015. Global growth worries, after the bursting of a bubble in Chinese equities, Greece’s debt default and what proved to be a temporary halt in Quantitative Easing in the USA combined to hold back the Dow and buck history at the same time.

“Investors will therefore have to keep a close eye on events in Washington, but an even closer one of inflation, interest rates and corporate earnings growth, as well as valuation, which remains the ultimate arbiter of investment return – after the 1973-74 collapse and 1994’s stumble, US equities looked good value, at least with the benefit of hindsight, and unfortunately that may not necessarily be the case right now, even after 2022’s US stock market falls.

“According to Professor Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio, another major US index, the S&P 500, is still trading on more than 27 times earnings, a valuation multiple that has been historically commensurate with market tops and not market bottoms.”