As the United States approaches its November midterm legislative elections, a historical pattern suggests that the political “hot air” may soon transform into a significant tailwind for sharemarkets globally, including the ASX. Despite recent market fluctuations, analysts point to the period following midterms as historically the most consistently positive nine-month span for stocks. This phenomenon is largely attributed to the increased legislative gridlock that typically ensues, which often stifles major, controversial legislation for the subsequent two years, regardless of the election outcome.
The current political landscape in the US indicates a high likelihood of this gridlock. Republicans hold narrow majorities in both the House of Representatives and the Senate, with historical trends showing the sitting president’s party losing seats in the vast majority of midterms. With many House and Senate seats considered toss-ups, Democrats are poised to potentially gain control of one or both chambers. Even if Republicans retain control, their margins are expected to remain thin, potentially leading to increased intra-party disagreements and a similar outcome of legislative inertia, particularly as President Trump enters a “lame duck” phase.
This legislative quietude, despite voter frustration with perceived inaction, is consistently favoured by stock markets. Big, divisive legislation creates uncertainty by designating clear winners and losers, whereas gridlock mitigates such risks. Historical data from 1925 shows the S&P 500 gaining in 84 per cent of midterm year fourth quarters, and 88 per cent in the first and second quarters of the following year. Combined, these three quarters have been positive 91 per cent of the time, averaging 19.8 per cent returns in US dollars. Given the strong correlation between US and non-US equities, with the ASX and S&P 500 showing a significantly positive correlation of 0.67, this “midterm miracle” is expected to extend its influence to markets Down Under.
