Elections and the Market

When it comes to midterm election years, history suggests that letting politics guide investment decisions can be a costly mistake.  The primary reason is that the US stock market follows a very predictable four-year presidential election cycle that is well documented.  Market returns vary consistently on which year of the presidential term is underway rather than the investing environment created by corporate earnings, monetary policy and economic fundamentals. The best years of the presidential term are typically Year 3 (+17.2%), Year 4 (+12.5%) and Year 1 (+8.4%). On average, annual gains in the S&P 500 for midterm years (Year 2) are approximately 7%, making them among the weakest performing years for the US stock market.  2026 could well prove to be an outlier as stocks have thus far advanced 12%, marking the sixth-best start to a midterm election year since 1926. 

Market returns in midterm years can experience sharp volatility depending on political and economic uncertainty.  Surprisingly, the market strength in 2026 has coincided with relatively limited volatility with just 4 days of wide price swings (+/- 2%) compared to the recent past midterm years of 2022 (46 days) and 2018 (20 days).  The Cboe Volatility Index (VIX) has remained below the long-term trend line of 20.0 for most of 2026, except for February and March (start of Iran conflict). How has Trump 2.0 been for the stock market?  Pretty good, with strong performance in both Year 1 (+14.1%) and thus far in Year 2 (+12.0%). Performance in Trump 1.0 was also good – Year 1 (+19.1%), Year 2 (-6.2%), Year 3 (+28.9%) and Year 4 (+16.2%).

Which political party is better for the stock market?  Suggestions that a win by a Republican Presidential candidate (often considered more business-friendly) over a Democratic candidate would be better for the stock market are not supported by history. Since the Reagan years we see the following average annual market returns: under Democratic President (+9.7%) and under Republican President (+7.7%).  The prevailing wisdom is that midterm elections add political instability and uncertainty to the mix of other factors (like GDP growth, interest rates and unemployment) that may already be impacting the broader market. In the weeks leading up to an election, we are bombarded with anecdotal evidence that if considered in isolation can be misleading. Another common premise suggests that a divided congress will accomplish little legislatively and that the resulting lack of progress is supportive of stock price growth. A divided government often results in broader compromise on important issues like taxation, federal spending and infrastructure.  

There is, however, more to this story. In fact, during election years in which Republicans control Congress, the market returns a solid +19.7%, versus an average gain of +7.6% with a divided Congress and just 3.2% when Democrats are in control. Elections that result in a change in composition, by party, in either the House or Senate tend to be preceded by periods of market underperformance – not what the market is suggesting thus far in 2026. Stock price performance in the summer leading up to a midterm election can offer some insight into which party will be successful in November. When the market climbs from August through October the incumbent party has a great track record winning 82% of the time. In contrast, a falling market during the same time is predictive (over 86%) of a win by the replacement party. Thus far, for August and September (and the majority of October) the S&P 500 has moved up +3.05%.