ROI-US stocks always rise after midterms. Is this time different?: McGeever

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The opinions expressed here are those of the author, a columnist for Reuters.
By Jamie McGeever
ORLANDO, Florida, Nov 7 (Reuters) - The market meltdown following the Republicans' electoral drubbing on Tuesday could signal a rough year ahead for Wall Street. Yet history shows that US stocks typically rise in the year following midterm elections, and usually by quite a bit. 
But if US President Donald Trump's second term has taught us anything, it is that many of the economic assumptions and market playbooks that shaped investor thinking for decades may no longer apply. 
So as the dust settles on the landmark midterms, the question is: is this time different? Investors' immediate reaction to the Democrats' thumping victory was certainly eye-opening — Wall Street shed $3.2 trillion and US chip stocks .SOX plunged 12% in their second-biggest fall on record on Thursday — amid worries that the Democratic-controlled Congress could slow the breakneck buildout of AI data centers.
Is this nervousness a sign of things to come? 
     
THE HISTORICAL PLAYBOOK
If history rhymes, the outlook for the year after a midterm should be positive. In the 12 months after every midterm election since 1950, the S&P 500 .SPX has risen, gaining around 15% on average.
But the stock market rises over almost any 12-month period, one might argue. That's true, which makes a deeper dive into the data essential.     
Since World War Two, the S&P 500 has risen in calendar years 71% of the time, posting an average gain of just over 9% and a median rise of 11.6%, according to analysts at Deutsche Bank. 
So what about the 12 months after a midterm election? Between 1946 and 2022, the market was up 100% of the time after the vote, posting an average gain of 14.4% and a median return of 13.7%. That's a roughly 4- to 5-percentage-point advantage on average and around 2 points at the median.
What accounts for this? Partly, it's because of what typically happens before the midterms. The S&P 500's average rise in midterm election years since 1949 has been only 8.4%, according to Keith Lerner, chief investment officer at Truist Wealth Advisory. Uncertainty around the vote, balance-of-power shifts and policy implications builds ahead of the election and can weigh on returns.
     After the vote, this uncertainty is, in theory, removed, while divided government and political gridlock reduce the likelihood of major, radical policy changes. Investors typically like that.
Lerner also notes a remarkable curiosity that helps explain the post-midterm outperformance. Since 1950, the US economy has never been in recession during the third year of a presidential term, that is, the calendar year after the midterms. 
Lerner calculates that the S&P 500's average return in these years is 20.9%, significantly higher than the average in years one, two, and four across presidential cycles. While there is no single catalyst, stimulative fiscal policy enacted in the first two years often takes time to filter through, while Federal Reserve rate hikes historically just tend not to bite in that window. 
     
     CRACKS IN THE PLAYBOOK
     Yet no two periods are ever the same, and there are some pretty striking differences between the current economic and market environment and those of midterms past. A few stand out.
First, the stock market has performed strongly in this midterm election year, with the S&P 500 still just 5% below its all-time high even after Thursday's selloff. That means the potential for further strong gains could be limited. 
On the flip side, there is still plenty of room for more reversals. Prior to Thursday's market slump, the S&P 500's maximum drawdown this year was only 9%. That's about half the typical maximum pullback of around 18% to 19% in a midterm year, according to JPMorgan.
This is particularly important because the US stock market has never been so concentrated. Whether it's the so-called "Magnificent Seven" group of Big Tech giants, the "hyperscalers" at the heart of the AI revolution, or the dozens of "AI-adjacent" companies involved in the wider buildout, it's a fact that earnings, returns, market capitalization and investment have never revolved around so few companies. 
As recent weeks have shown, even if just a handful of tech giants fail to meet the lofty expectations baked into current prices, the benchmark indices may fall sharply.
At the root of this concentration is the biggest investment boom in history. The astronomical sums being plowed into AI, expected to top $10 trillion between 2025 and 2032 by some estimates, have lifted stock prices and household wealth to record levels and, according to many observers, are inflating a huge bubble. 
Parallels with the dotcom boom and bust are hard to ignore. The internet transformed the world and spawned many of today's trillion-dollar tech giants, but that journey also included overspending, hubris and "irrational exuberance" that led to the spectacular market crash a quarter of a century ago. Is the AI spending binge, and the mounting debt being raised to fund it, an even greater misallocation of capital?
Finally, there's the interest rate outlook. The Federal Reserve raised rates by a quarter of a percentage point in September, and financial markets are betting it will hike another half percentage point next year, bringing cumulative tightening to 75 basis points. Yet the average tightening cycle since 1954 has been 400 bps and lasted 23 months, according to the Federal Reserve Bank of Chicago. 
In other words, markets are currently positioned for the mildest tightening cycle in Fed history. That's a benign projection, especially with inflation approaching six years above target. While an AI slowdown could weigh on growth, the Fed may also find itself facing the specter of stagflation if conflicts in the Middle East and Ukraine keep energy prices elevated. 
Either way, Wall Street does not appear prepared for a more aggressive Fed. History offers little comfort here: post-midterm Fed policy shows no consistent playbook, with the central bank having hiked, eased or held rates steady in different cycles.
     
THE REVERSAL RISK
If the post-midterm pattern holds and the US avoids recession in 2027, investors could be in for a bumper year. But that's far from a certainty. 
Recession isn't many people's base case for the coming year, but the turbulence rocking tech stocks right now risks triggering a deeper economic earthquake. Given how pivotal the AI investment boom is to Wall Street and the country's financial well-being, a downturn or sudden reversal could bring the "R-word" into sharp focus.
On the subject of gloomy historical footnotes, the only two exceptions to the post-midterm outperformance pattern in almost a century are 1930 and 1938. The 12 months that followed these years were marked by the Great Depression and the buildup to World War Two.
This time is different, right?
     
     
(The opinions expressed here are those of the author, a columnist for Reuters)
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The S&P 500 always rises in the year after US midterm elections https://fingfx.thomsonreuters.com/gfx/mkt/byvragraxpe/Election1.png
US economy never enters recession in year after midterm elections https://fingfx.thomsonreuters.com/gfx/mkt/lbvgxkoxzpq/Election2.png
(By Jamie McGeever, Editing by Marguerita Choy and Anna Szymanski)
((jamie.mcgeever@thomsonreuters.com; Reuters Messaging: jamie.mcgeever.reuters.com@reuters.net/))