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Washington Makes Headlines. What Does History Say About the Stock Market?
By Kevin Kull, Financial Advisor
Every two years, America holds an election. Politicians promise to save the country, television commentators predict the end of civilization, and investors begin wondering whether they should sell everything and buy gold, canned beans and a cabin in Montana.
Then something interesting often happens: the stock market recovers.
Historically, the S&P 500 has tended to perform well in the 12 months following U.S. midterm elections. One commonly cited analysis covering the period since 1950 finds an average gain of roughly 18% during the year after a midterm election.
That is enough to get investors' attention. But does it mean stocks are destined to rise after the next election? And should investors change their portfolios to take advantage of the pattern?
The answer requires a little more perspective.
1. The Stock Market After Midterm Elections: Why History Gets Investors' Attention
Midterm elections can change control of Congress and influence the direction of taxes, spending, regulation and economic policy. Markets generally dislike uncertainty.
They prefer knowing what might happen, even if what might happen isn't particularly wonderful.
There are a few reasons stocks have historically performed well after midterms:
Uncertainty comes off the table.
Investors no longer have to speculate as much about which party will control Congress or what that might mean for policy.
Some of the bad news may already be priced in.
Markets are forward-looking. If investors have spent months worrying about a potential political outcome, some of that concern may already be reflected in stock prices. When the feared outcome turns out to be manageable, stocks can recover.
The business cycle matters more than campaign slogans.
Corporate earnings, interest rates, inflation, consumer spending and economic growth have enormous influence on stock prices. A strong economy can help stocks under either party. A recession can hurt them regardless of who won the election.
And eventually, politicians have to govern. Campaign season is full of promises. Governing season is full of negotiations, compromises and press conferences explaining why the original promise now requires a committee.
Investors may find that predictability more valuable than political victory itself.
2. Does the Political Party in Power Determine Stock Market Returns?
One of the most persistent investing myths is that the stock market automatically rises when a particular party wins and crashes when the other party does.
Reality is considerably less convenient for political arguments.
Markets have performed well under presidents from both major parties. They have also experienced painful declines under both. Congress can influence policy, but it does not control every variable affecting corporate earnings, global trade, inflation or interest rates.
Think of the President as one person driving a very complicated bus. The Federal Reserve is operating some of the controls, the global economy is messing with the steering wheel, and a geopolitical crisis may be throwing rocks at the windshield.
Meanwhile, investors are trying to decide whether the bus company deserves a higher valuation.
It's complicated.
3. Should You Buy Stocks After the Midterm Elections?
Not necessarily. Historical trends provide useful context, but they are not a reliable market-timing strategy.
Averages hide volatility. A strong average return can coexist with individual years of substantial losses. Every election is different, economic conditions change, and the market may move well before election night.
Even if the average post-election year is positive, history doesn't tell you the best day to invest.
For long-term investors, a diversified portfolio and a plan suited to their financial goals generally offer a more dependable foundation than trying to predict the market from the election calendar.
The historical pattern is interesting. It's not a magic trick.
And that brings us to a question worth considering beyond the election: how much stock market risk should your portfolio actually be taking?
4. 100% Stocks vs. a 60/40 Portfolio: Is Playing It Safe Costing You Growth?
The stock market is a roller coaster. Bonds are more like a leisurely train ride. The question is whether you're investing for the long haul or need to get off at the next stop.
The traditional 60% stocks and 40% bonds portfolio has remained popular for decades because it offers a blend of growth and stability. It allows investors to participate in the stock market without taking the full brunt of every market decline.
But there is a trade-off: the same bonds that can make a portfolio feel safer can also reduce its long-term growth potential.
For investors with decades before they need their money, a stock-heavy portfolio may offer a compelling advantage.
How Stocks and Bonds Affect Long-Term Investment Returns
Stocks represent ownership in businesses. When those businesses grow earnings, expand operations and become more profitable, shareholders can benefit through rising stock prices and dividends.
Bonds work differently. Investors generally lend money to governments or corporations in exchange for interest payments and the return of principal at maturity, assuming the issuer meets its obligations.
Both investments serve a purpose. But over long periods, stocks have historically delivered higher returns than high-quality bonds, compensating investors for taking on greater risk.
Bonds can help provide a steadier ride when stock markets become volatile. The trade-off is that a portfolio with more bonds may participate less in periods of strong stock market growth. Finding the right balance depends on how much volatility an investor is comfortable taking on.
The point isn't that stocks win every year. It's that even a modest difference in annualized returns can have a substantial effect when compounding has decades
to work.
Bonds Provide Stability, but They Have an Opportunity Cost
Let's be fair to bonds. They aren't the villain in every investment story.
Bonds can provide income, diversify a portfolio and help cushion certain stock market declines. A 60/40 portfolio can also give investors the confidence to remain invested during difficult markets.
That matters because the theoretically perfect portfolio is worthless if its owner panics, sells everything and spends the next five years waiting for the all-clear signal.
But bonds have an opportunity cost. When stocks deliver strong returns, a portfolio holding 40% bonds, for instance, has less money participating in that growth. Over decades, those foregone returns can compound into a meaningful difference.
The goal isn't to eliminate bonds. It's to make sure the bonds you own serve a purpose that justifies the trade-off.
5. Why Your 401(k) May Be Outperforming Your Investment Portfolio
A brokerage account isn't automatically short-term money, just as a 401(k) isn't automatically long-term money in every circumstance. A brokerage account intended for retirement can have a decades-long horizon, while someone approaching retirement may need some 401(k) assets for near-term spending.
You may have noticed that your 401(k) is beating your investment portfolio. One possible reason is that the two accounts have different jobs.
Your investment portfolio may include money market funds or bonds to provide liquidity for near-term needs. Your 401(k), on the other hand, may be invested more heavily in stocks because it is intended for retirement many years away.
For someone who is 35 and investing for retirement at 65, a market decline at age 40 can be uncomfortable, but it doesn't necessarily mean the retirement plan is in trouble. There are still 25 years for the portfolio to recover and grow.
In fact, someone who continues contributing during a downturn can purchase shares at lower prices. That's not much consolation when the market is falling, but it can be beneficial over time.
A diversified 100% stock portfolio may be reasonable for investors with a long time horizon, the financial capacity to withstand significant declines and the emotional discipline to stay invested in our opinion.
That last part deserves emphasis. An all-stock portfolio can lose 30%, 40% or more during severe bear markets. If watching your account balance plunge would cause you to sell at the worst possible time, the higher expected return may not be worth the behavioral risk.
And as retirement approaches, the calculation changes. Someone planning to withdraw from a portfolio soon has less time to recover from a major decline.
Gradually introducing bonds and other less volatile assets can help manage that risk.
The important point is that the account type doesn't determine the investment strategy. The purpose of the money does.
A brokerage account isn't automatically short-term money, just as a 401(k) isn't automatically long-term money in every circumstance. A brokerage account intended for retirement can have a decades-long horizon, while someone approaching retirement may need some 401(k) assets for near-term spending.
6. How to Invest Based on When You Need the Money
Age-based rules of thumb can be helpful starting points, but they aren't universal laws of investing.
Instead, consider organizing investments around their intended use, in our opinion:
Long-term retirement money: A stock-heavy portfolio may be appropriate for investors with decades to invest and the ability to tolerate significant declines.
Medium-term goals: A balanced allocation may help manage the trade-off between growth and stability.
Short-term spending needs: Cash and high-quality, short-duration fixed-income investments may help reduce the risk of having to sell stocks during a downturn.
Different dollars have different jobs. Money earmarked for retirement in 2055 has a very different assignment from money needed to pay tuition next September.
7. The Biggest Investment Risk Might Be Playing It Too Safe
Investors naturally worry about losing money. Nobody enjoys opening a statement and discovering that their portfolio has taken an unscheduled vacation from its previous high.
But there's another risk that receives less attention: failing to grow wealth enough to meet future goals.
Inflation gradually erodes purchasing power. Retirement can last 25 or 30 years. Healthcare costs can rise. A portfolio that appears conservative today may not generate enough growth to support tomorrow's spending.
This doesn't mean everyone should abandon bonds and buy stocks with reckless enthusiasm. It means risk should be evaluated from both sides: the risk of losing money in a downturn and the risk of not earning enough to reach your goals.
A 100% stock portfolio may maximize exposure to equity-market risk. It does not maximize certainty, and it certainly doesn't guarantee the highest return over every investment period.
The appropriate allocation depends on whether you can withstand the downside in exchange for the possibility of greater long-term growth.
The Bottom Line: Give Every Dollar a Job
The historical record suggests that the 12 months after midterm elections have often been favorable for the S&P 500. Political uncertainty may ease after voting, allowing investors to refocus on earnings and economic conditions.
That's a reason for cautious optimism, not a reason to bet the retirement account on election night. If history repeats itself, investors may get a solid year after the midterms. If it doesn't, the market will happily remind everyone that it never signed a contract with history.
How should you invest right now? It depends on your time horizon, liquidity needs, taxes, fees, diversification and individual risk tolerance.
The consideration for a 100% stock portfolio isn't that bonds are bad or that conservative investors are doing something wrong. It's that long-term investors may be sacrificing meaningful growth by holding more bonds than they actually need.
Investing isn't about winning every quarter, avoiding every market decline or bragging about your portfolio at dinner parties. It's about building enough wealth to fund the life you want.
Politicians may spend the year arguing about who should run the country. Investors should spend more time considering what the companies in their portfolios are actually earning.
And perhaps the best election-related investment advice is this: don't let a campaign advertisement make you sell your index fund.
S&P 500 Index is a capitalization-weighted index calculated on a total return basis with dividends reinvested. The index includes 500 widely held U.S. market industrial, utility, transportation and financial companies.
*Hypothetical illustration assumes annual compounding, no additional contributions or withdrawals, and no taxes or investment expenses. The returns shown are assumptions, not forecasts or guarantees of future performance. Actual investment results will vary.
**These are hypothetical assumptions, not forecasts or guaranteed returns. Actual investment returns won't arrive in a neat, orderly fashion. Stocks can underperform bonds for extended periods, and a 60/40 portfolio can sometimes outperform an all-stock portfolio.
Wells Fargo Advisors Financial Network did not assist in the preparation of this report, and its accuracy and completeness are not guaranteed. The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Additional information is available upon request.
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