Mid-term election years could provide unique buying opportunity

Volatility has returned after a historical period of very tepid market action. January witnessed the peak of optimism as tailwinds from tax reform created a euphoric start to the year and stocks rallied nearly six percent for the month. However, signs of an overheating economy that was receiving fiscal stimulus at the later stages of a maturing business cycle quickly sparked inflation fears, pushing interest rates higher, as the 10-year Treasury marched toward three percent, triggering market turmoil.

Tax reform is also causing concern that lower tax revenue will increase the budget deficit, which will add to already ballooning national debt levels. In fact, the Congressional Budget Office now projects that the deficit will reach $1 trillion in 2020. To make matters worse, President Trump's rhetoric on tariffs and trade wars (primarily with China) caused more uncertainty for the markets, ultimately erasing all gains for the year as stocks sold off into correction territory.

This type of market action is setting up for a traditional mid-term election year, which has historically been the most challenging year of the four-year presidential cycle. Mid-term election years usually deliver a period of negative sentiment, creating volatility and unrest, causing stocks to sell off. However, history has also shown that the selling pressure tends to dissipate as the year progresses, setting up for a strong year-end rally with gains into the following year. As we inch closer to election time, President Donald Trump will be doing everything he can to generate momentum going into the election in favor of the Republican Party.

Since 1962, mid-term years have seen an average correction for the S&P 500 Index of nearly 19%, which all proved to be substantial buying opportunities for domestic equity market participants. Traditionally, markets peak between December and May, starting a correction process that typically lasts through summer or into early fall. From there, the recovery returns have been tremendously bullish, posting 35.88% returns on average for the following 12 months.

This mid-term election cycle looks to be on par with the past. The stock market peaked on Jan. 26, followed by a quick and vicious correction of 10%, that troughed on Feb. 8. It is possible that the lows have been seen for the year. However, there could be multiple retests of that low as the markets have been range-bound and may continue to be choppy as we enter the typically weak summer trading months.

We have a very unconventional president who measures his success not by his approval rating, but rather by the performance of the stock market. The timing and practice of tariffs were strategically used to bring China to the negotiation table, while leaving ample time for uncertainty to alleviate the markets before election time. China has already softened their position on tariffs for foreign imported vehicles and reduced barriers for foreign investments. If the two countries form a long-term trade agreement in the near future, it should eliminate trade war fears, easing a significant cloud hanging over this market.

President Trump will need economic momentum on his side as we head into the mid-term election, as the odds of losing the House of Representatives are relatively high. He will eventually revert to his softer tone, promoting a business-friendly economy which should translate into a strong stock market, with the hopes of winning over voters as we head into the elections. For those that can be disciplined and ride out the storm, historical data supports that future returns could be promising, adding another leg to this historic bull market run.


James Quackenbush, CFA, is a senior domestic equity analyst for Karpus Investment Management, a local independent, registered investment advisor managing assets for individuals, corporations, non-profits and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534, (585) 586-4680.

Published: Fri, May 11, 2018


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