A strong market rally could be weeks away if the U.S. midterm election can put anxious stock investors at ease

If the U.S. midterm election cycle this year is anything like previous ones, the stock market will carve out a major right-hand low around Election Day in November.

That should give some hope to beleaguered investors whose equity holdings have suffered double-digit losses so far this year. A significant rally could be in a few weeks.

I am referring to the historical stock market trend of weakness before midterm and strength after midterm. This pattern is plotted in the chart below, which is based on the July-December average performance of the Dow Jones Industrial Average
DJIA,
+1.19%

in the past 17 years of midterm elections (since 1954).

Although the date of the average in this chart is in October, the actual all-time lows may come earlier or later. It all depends on when the stock market starts to anticipate the outcome of the midterms and therefore discount it. A good guess is that this year’s low will come later, given the uncertainty over the election outcome, particularly in the US Senate.

There is always the possibility that the pre-midterm dip will occur before Election Day. It wouldn’t be inconsistent with this year’s all-time low to have occurred the day after Labor Day, in fact. As of September 9, the S&P 500
SPX,
+1.53%

was more than 4% above this low level.

It should be noted how remarkable it is that a pattern emerges when averaging several years of stock market fluctuations. Although each year traces a unique path, the highs and lows usually cancel each other out, leaving the average to be a gradual upward line. A trend must be pronounced enough in the historical data for a deviation as pronounced as that shown in the accompanying graph.

This pre- and post-midterm trend is so pronounced that it is the origin of the famous seasonal pattern known as the “Halloween indicator,” where the stock market is strongest between October 31 and May 1 and the lowest the other six months. of the year. Yet, take away the six months before and after the midterm elections and the Halloween indicator disappears.

The underlying data appears in the table below. The cell marked with a single asterisk

refers to the current semester, while the cell marked with a double asterisk (**) corresponds to the semester starting at the end of October 2022.

Presidential cycle year since 1954

Average Dow gain between Halloween and May 1

Average Dow gain from May 1 to Halloween

1

6.4%

1.5%

2

4.7%

-0.2%*

3

15.1%**

1.1%

4

4.3%

0.5%

So if you’re tempted to bet on the Halloween Indicator, your time is fast approaching. If you miss it, you won’t get another chance until the midterms of 2026. Credit for discovering that the Halloween indicator dates back to the months before and after the midterms goes to Terry Marsh, professor emeritus of finance at the University of California at Berkeley and CEO of Quantal International, and Kam Fong Chan, senior lecturer in finance at the University of Queensland in Australia.Their research on this model was published in July 2021 in the Journal of Financial Economics

.

The likely source of the pattern, the researchers say, is the uncertainty that exists before the midterms and the resolution of that uncertainty after the election. They note that it doesn’t matter which party dominates Congress before the midterms and which becomes the majority party afterwards. According to them, the model exists because the stock market craves certainty, even when the source of that certainty may not be in line with each investor’s political preferences. Mark Hulbert is a regular MarketWatch contributor. His Hulbert Ratings tracks investment newsletters that pay a fixed fee to be audited. He can be reached at

mark@hulbertratings.com After:

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