Seemingly endless campaigning and at least some partisan bickering should soon be behind us now that voting is complete in the 2022 midterm elections. A runoff election for Georgia’s U.S. Senate seat remains, but in the meantime it’s time for investors to contemplate what may lie ahead.

A “red wave” of Republican Party midterm dominance that some polls and analysts predicted did not materialize. Days after the voting ended, election officials continued tallying results in several close races for U.S. House of Representative and Senate seats. The ultimate outcome likely will be a politically divided federal government for the next two years.

Despite their differences, the two parties agree on a few key matters that may help move forward specific legislative priorities. Continued infrastructure repairs and improvement and increased defense spending enjoy bipartisan support, and some agreement exists on ways to curb health care costs.

From a market perspective, history shows that a divided government can benefit investors. From 1933 through 2020, the S&P 500^® Index averaged a 14% annualized return in all years of split congressional control, compared with 11% during that entire 88-year period.^{1 2}

Simply getting past the election could be a positive. Since 1950, the S&P 500 has delivered positive results — usually double-digits — during the 12 months following the election, regardless of which party controlled Congress or occupied the White House. See Figure 1.

Political Uncertainty Is Reduced, But Bigger Worries Remain

Since 1970, midterm election years have exhibited a clear pattern of higher equity market turbulence than other years of the presidential cycle. Also, as we’ve experienced this year, it’s common to see equity fund outflows in the months leading up to midterm elections.³

Even though political uncertainty has contributed to the rocky investment backdrop in 2022, it pales compared to other factors at play. Global central banks, led by the Federal Reserve, have raised interest rates aggressively to fight surging inflation worsened by the war in Ukraine.

Higher rates have exacerbated equity market volatility and losses. The S&P 500 plunged nearly 18% in the first 10 months of this year amid rampant concerns that rising interest rates would jolt the slowing economy into a recession.

Past Reflections of Present Conditions

Though no two election cycles are created the same, 2022 is reminiscent of two previous midterm years.

In 1970, the world was recovering from an influenza pandemic two years earlier. At the same time, the Vietnam War was dominating global headlines, and rising inflation was hampering the U.S. economy.

Similarly, geopolitical tension was high, and inflation plagued the economy as the 1982 midterms approached. The U.S. and the Soviet Union were engaged in contentious nuclear arms negotiations, made more difficult by the Soviet imposition of martial law in Poland.

The S&P 500 fell substantially in the first half of those years, as in 2022. But in each historical instance, the year ended with a rally.

Historically, Stocks Head Higher After Midterm Elections

Investors don’t need to find midterm cycles analogous to 2022 as they prepare for 2023. That’s because U.S. equity markets have historically rallied after virtually ALL midterm elections.

Since the Civil War, U.S. equity market returns in the six months after midterm elections have averaged five times higher than returns in all other months. More recently, from 1954 through mid-2017, the S&P 500 surged an average of 25% in the quarter of the midterm election and the two quarters immediately afterward.⁴ Historically, this performance coincides with investors exhibiting substantially less uncertainty and risk aversion after votes are counted.

Finally, the S&P 500 since 1950 has posted an impressive winning streak: positive returns in all 18 12-month periods after a midterm election.⁵ Its average gain of 15% in those stretches more than doubles the average gain in all other comparable 12-month periods.⁶

Remain Focused on Long-Term Investment Strategies

While the noise from political events may affect investment performance in short bursts, elections don’t determine financial market outcomes over longer periods. Therefore, we think markets will refocus on the most critical issues — inflation and economic growth.

Investors face important questions. Are you comfortable with how your portfolio is positioned in an environment of rising economic risk? Do you have adequate inflation protection? Does your strategy account for an extended period of rising rates?

Thomas Edison famously said, "Good fortune is what happens when opportunity meets with planning.” We think opportunities for investors to reduce risks and enhance returns are always present, especially when markets are volatile.

In our view, success comes from committing to a prudent long-term plan and executing it with a disciplined investment strategy.