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Analysis: Recession fears threaten perfect record of U.S. stock market gains after midterm

NEW YORK, Oct 27 (Reuters) – A potential recession could end a run of gains for U.S. stocks that has followed every midterm election since World War II.

Since 1946, the S&P 500 (.SPX) climbed 19 out of 19 times in the 12-month period after the midterm elections, according to Deutsche Bank data. Midterms, which determine which political party controls the US Congress, take place every four years. This year it is November 8.

Investors cite a number of possible reasons for the post-midterm tailwind. Voting helps clarify political perspectives regardless of the outcome because the makeup of Congress is known. At the same time, the party that wins the presidency tends to lose seats in a midterm election, creating a political stalemate that prevents either party from making sweeping policy changes – a configuration that investors seem to favor.

Whatever the reason, a prolonged period of stock market gains would be a welcome development for investors after a slump in which the S&P 500 has lost nearly 20% year-to-date, boosted by aggressive rises Federal Reserve interest rates to curb soaring inflation. .

“Performance over the 12 months following mid-term is consistent with positive and above-average market returns,” said Angelo Kourkafas, investment strategist at Edward Jones.

This time, however, “the driving force behind the markets has been the Fed,” Kourkafas said. “So I wouldn’t necessarily dismiss the effect of the midterm elections, but other factors supersede it.”

The focus on post-election performance comes as investors digest a rally that sent the S&P 500 up more than 7% from recent lows. Analysts attributed the move to everything from hopes of an upcoming slowdown in the Fed’s pace of monetary policy tightening to cash-rich funds jumping aboard on market rebounds.

Although the focus has been on the Fed, the looming election and broader seasonal trends could be another factor in favor of stocks, market watchers said.

Data from Oxford Economics shows the S&P 500 since 1950 has risen an average of 15% in the 12 months following the midterm vote, with the rally typically starting a few weeks before the election.

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Other seasonal trends caught the attention of investors. November and December rank as the second and third best performing months of the year since 1950, with average S&P 500 gains of 1.7% and 1.5%, according to the Stock Trader’s Almanac.

Either way, investors have been more eager to buy lately, as evidenced by data from BofA Global Research showing three-week inflows into individual stocks measured as a percentage of S&P 500 market value near their highest level since 2008.

RISKS FOR A RALLY

Still, some believe markets will struggle to mount a lasting rally if the Fed’s aggressive monetary policy pushes the United States into a recession. Economic data and recent earnings results have painted a mixed picture, including disappointing reports this week from Microsoft Corp. (MSFT.O) and Alphabet Inc. (GOOGL.O).

Another recession warning came earlier this week, when yields on three-month Treasuries topped those on 10-year Treasuries, a signal that preceded past downturns.

“The recession outweighs factors from the previous U.S. midterm elections that were seen as positive for equities, such as the resulting political stalemate,” BlackRock strategists said in a note this week, adding that they were “not chasing bear market rallies”.

Meanwhile, the current inflationary environment makes post-medium term fiscal stimulus less likely, another factor that could limit equity gains.

While a post-midterm rally can’t be ruled out, “I just think that in some respects the environment is again set against a significant return to markets next year,” said strategist Michael Arone. Chief Investment Officer at State Street Global Advisors.

Still, some investors continue to see intermediaries as potential upside for stocks.

Stocks have historically performed better in times of divided government. With Republicans favored in the polls and markets betting to wrest control of the House of Representatives and possibly the Senate while Democrat Joe Biden remains in the White House, such an outcome could be increasingly likely.

Average annual returns for the S&P 500 have been 14% in a divided Congress and 13% in a Republican-held Congress under a Democratic president, according to data since 1932 analyzed by RBC Capital Markets. That compares to 10% when Democrats controlled the presidency and Congress.

Whoever wins, “the political uncertainty disappears,” said Brian Overby, senior market strategist at Ally. “At least you know what the agenda is and companies can plan accordingly.”

Reporting by Lewis Krauskopf in New York Editing by Ira Iosebashvili and Matthew Lewis

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