Stocks Skipped the Midterm Blues. Will the Post-Election Rally Be Smaller?
Stocks rose on Tuesday, pushing the S&P 500 to an all-time high. And many investors seem to expect even better days ahead, especially once the midterms are in the review mirror. But those of you counting on next year’s stock market to deliver the usual post-midterm bounty may discover that Wall Street has already helped itself to part of the feast.
It’s easy to see why many investors expect good times ahead. The historical record of the stock market’s performance following midterm elections is impressive. Every midterm election since 1946 has been followed by a positive one-year return for the S&P 500. The average gain was 14.4 percent. With November 3 approaching, that is an inviting number to pencil into expectations for the next twelve months.
The trouble is that the usual weakness preceding those gains has been conspicuously absent. Midterm years generally have been the disappointing stretch of the presidential cycle. BlackRock puts their average annual stock market return at 7.5 percent, against 12.4 percent in other years. Election anxiety has often accompanied a difficult summer, followed by a rally beginning roughly a month before the vote.
U.S. Bank’s study of 31 midterm cycles from 1900 to 2025 puts the average return in the 12 months before a midterm at 2.9 percent, against 8.9 percent for all years in that sample and 12.4 percent in the 12 months after. Since 1980, the performance has been stronger on both sides of the election, about 8.7 percent before and 17.5 percent after, but the gap remains. Fidelity’s analysts looked at the period following the Second World War and found a roughly five percent gain in the year ahead of the midterm versus about 14.5 percent after.
Those pre-election gains mask what tends to be a rough summer. Longview Economics finds an average peak-to-trough drawdown of about 19 percent in the year before the election, across 25 cycles since 1926. Even setting aside elections close to a recession, most still had a stock market correction of more than 10 percent, and several exceeded 20 percent. And usually, the sell-off occurs in the summer months prior to the election.
This year we seemed to have skipped the summertime blues. The S&P 500 returned 12.7 percent, including dividends, through September. The comparable midterm-year average since 1950 was just 0.9 percent. BlackRock also documents unusually quiet trading: only four daily moves of at least two percent in either direction through August, compared with 20 during 2018 and 46 during 2022.
Why Does the Market Rally After Midterms?
A relief rally presumably works best when investors first experience something requiring relief.
That matters because the explanations for post-midterm strength often depend on the unpleasantness that comes before it. The leading theory is that uncertainty about congressional control makes investors demand extra compensation for holding stocks. That depresses prices. As polls clarify the likely outcome and voting settles the question, the uncertainty discount shrinks and share prices rise.
A 2021 paper in the Journal of Financial Economics found evidence consistent with this mechanism. The election helps by resolving uncertainty, whatever the partisan outcome.
But a strong, comparatively calm market gives us less reason to expect a large release of pent-up anxiety this time. An election surprise could still move stock prices. The historical sequence, however, has already missed an important step.
Another explanation is simpler: some of the celebrated post-midterm rally is a rebound. Stocks entering autumn after a punishing decline have more ground to recover. The subsequent gains get counted as election-cycle returns even when falling inflation, improving earnings, or the end of a bear market deserves much of the credit.
Since 1950, when stocks were already higher through September of a midterm year, the following fifteen months — October of the election year through December of the next — delivered an average total return of 25.4 percent. Following losing starts, the average was 37.7 percent. Both were substantial gains, but the weaker entries produced considerably larger recoveries. That is a longer window than the 14.4 percent figure, and it shows why a single average can obscure the difference between buying after losses and buying after gains.
The third explanation concerns political incentives. Presidents supposedly get painful decisions out of the way early and favor economic support as the next presidential election approaches. That could help stocks in year three, although it depends on actual policy and economic conditions.
Maybe Markets Are Just Getting More Efficient
In theory, none of this should happen at all. The midterms, after all, always resolve pre-election uncertainty. So investors should anticipate that and price it in without waiting for the election to occur. Similarly, investors anticipating a post-election rebound should price that in pre-election. At the very least, the recurrence of the pattern of a post-election boost should eventually make the pattern so well-expected that it doesn’t happen at all.
And there’s a hint that reality may finally be catching up to theory. We did have a sell-off this year; but it came early, running from January 27 to March 30. The S&P fell by around nine percent. This might have been investors selling in anticipation of the summertime blues. If that’s right, the recent strength of the stock market could be the typical post-election rally pulled forward. The lack of volatility could be a sign that investors have been correctly pricing the usual seasonality — which ironically eliminates it.
None of this requires the post-midterm winning streak to end. After strong entries, the next year has still finished higher. It does suggest that investors should distinguish a history of positive returns from an expectation of unusually large ones. This year’s strength has reduced the room for a recovery, while its calm raises questions about the size of any election relief.
Stocks can keep climbing on stronger profits and economic growth. But investors awaiting the customary electoral exhale should consider how little breath the market appears to be holding.
