Midterm Elections are the Big X-Factor in 2022. Will History Repeat?
The 2022 trading year is unique because it features midterm elections in November—such years are historically characterized by weaker returns and heightened volatility.
The 2022 trading year features midterm elections, and for the financial markets, that’s an important distinction. Midterm elections in the United States are the general elections that are held near the midpoint of a president’s four-year term of office.
Trading behavior in the stock market during previous midterm election years has demonstrated a fairly consistent pattern—according to historical data. Interestingly, returns during midterm election years have trailed the average returns of all years, on average.
For example, from 1942 to present, the average return in the S&P 500 during trading years that included midterm elections has been about 6%. That’s 3% lower than the average of all trading years over that same period, which was about 9%.
However, midterm election trading years also feature another important characteristic.
After the conclusion of the midterm elections in November, returns in the market during the remainder of the year have historically been higher on average, as compared to all trading years. This trend is illustrated in the chart below.
Source: MarketWatch
As shown above, the risk environment in the stock market appears to change after midterm elections, as uncertainty in the political spectrum dissipates.
Not surprisingly, additional historical data supports the notion that midterm election years are weaker than others, in terms of performance.
For example, when looking back at stock market performance during the average U.S. presidential term, historical data also shows that the second year of the four-year appointment tends to be the weakest. The second year of a four-year term also happens to capture midterm elections.
Considering that Joe Biden was elected President in November of 2020, that means his first full year in office was 2021. In turn, that means his second year in office—featuring midterm elections—will be 2022.
As shown below, market performance during the second year of a president’s four-year term has been the weakest, on average (according to historical data).
While there’s no guarantee that history repeats itself (especially amidst a global pandemic) the above suggests that relatively speaking, 2022 could be a weaker year in the stock market.
However, that also means bullish investors and traders could have a lot to look forward to in 2023.
Market Volatility During Election Years
Aside from overall returns, midterm election years have also tended to be more volatile than an “average” year in the stock market, according to historical data.
Volatility risk on average is higher during midterm election years as compared to all years, but this is especially true during the months leading up to the election, as highlighted below.
Source: CapitalGroup.com
According to data compiled by the CapitalGroup, midterm election years going back to 1970 have had a median standard deviation of returns of roughly 15%, which is about 2% higher than all other years (13%) during that period. Research conducted by tastytrade indicated that market volatility is also about two percentage points higher than average during trading years that feature presidential elections, as well.
Political Outcomes During Midterm Election Years
In terms of results at the ballot boxes, midterm elections haven’t historically been favorable for the political party of a sitting president.
Since 1966, there have been only two midterm elections (1998, 2002) in which the sitting president’s party actually picked up seats in Congress.
On average, midterm elections usually result in the loss of 28 combined seats in the House of Representatives and the Senate by the political party whose president currently occupies the White House. To wit, Republicans lost a total of 40 seats in Congress during the last midterms in 2018, when then-President Donald Trump occupied the Oval Office.
In 2022, a total of 469 seats in Congress are up for reelection, including 34 in the Senate and all 435 in the House.
And this time around, Republicans need to net only five additional seats to win a majority in the House, and only one additional seat in the Senate. Based on the aforementioned historical data, oddsmakers will likely be favoring Republicans to take control of both chambers come November.
To learn more about trading the markets during election years, readers are encouraged to review this previous installment of Options Jive on the tastytrade financial network.
Betting on politics? To follow the political prediction markets in 2022, tune in to the Luckbox podcast, The Prediction Trade.
Sage Anderson is a pseudonym. He’s an experienced trader of equity derivatives and has managed volatility-based portfolios as a former prop trading firm employee. He’s not an employee of Luckbox, tastytrade or any affiliated companies. Readers can direct questions about this blog or other trading-related subjects, to support@luckboxmagazine.com.
