The ‘midterm miracle’ set to fuel forward momentum for Australia’s stocks

It isn’t surprising that Australian stocks have paralleled US markets in midterm years. Picture: AFP

Who loves shrill, ugly elections fraught with campaign promises destined to disappoint? I do! You should, too – especially the upcoming Congressional “midterm” slugfests in the US. While voters definitely dislike the partisan cacophony, US midterms produce underappreciated-yet-demonstrable sharemarket rocket fuel. Australian stocks benefit big-time but indirectly from the legislative gridlock they create – and it is coming soon. That, coupled with your own falling post-election political uncertainty, provides a twin tailwind for the ASX. Here’s why political drivers north and south of the equator will propel 2022’s year-end.

Like Australia’s parliament, America’s legislature has a House of Representatives and a Senate. US voters select legislators independent of who heads government. November midterms in the president’s second year commonly flip Congressional control away from the president’s party. President Joe Biden’s Democrats now control both chambers by the thinnest of margins – in the House, by just 10 seats.

All 435 seats are up each midterm election – when the president’s party routinely loses seats. Losses spiral when the president’s popularity is low this late in the US summer. At 41 per cent, Biden’s approval rating is the lowest midterm summer rating in polling history. Unpopular presidents have suffered huge midterm party losses – averaging 38 seats – easily enough to flip control to the Republicans.

The Senate is murkier – dead even at 50-50 – with 34 seats on November’s ballot. Biden’s Vice President Kamala Harris has a deciding vote, giving Democrats the tiniest of edges. But just one seat flipping switches the Senate to Republican, too.

Despite tiny margins, as you know, Democrats have passed big, expansive spending bills and funded their regulatory goals – but just barely. Crucially, the party in power in each chamber has complete control over what bills advance to get voted upon. Either chamber switching in midterms effectively ends the other party’s legislative power. Yet that new opposition party in power, in this case Republicans, can’t override presidential vetoes. So nothing controversial happens. Voila: gridlock.

Stocks love it. They don’t prefer either party – but hate big, controversial legislation. Sweeping changes create winners and losers. Behavioural psychology teaches us that losers hate it more than winners love it. Hence, uncertainty rises. Gridlock zaps that uncertainty. Knowing rules can’t change much, businesses plan more confidently – deploy long-term capital. Investors feel more comfortable taking risk. Stocks pre-price that positively.

Don’t trust me on this. Consider history. Since good data start in 1925, America’s S&P 500 was basically flat in the first three quarters of midterm years (in US dollars). Shrill campaign rhetoric dampens sentiment. Extreme campaign promises ramp up uncertainty. But before Election Day, stocks begin pricing in the likely result – near-inevitable absolute or relative gridlock. Hence American midterm year Q4s sizzle – 6.3 per cent average gains, with positive returns in 83.3 per cent of them since 1925.

Stocks delight in a do-nothing government well into the next year – returns average 6.6 per cent and 5.5 per cent in the ensuing Q1 and Q2, respectively. Returns were historically positive in 87.5 per cent of both quarters. Midterm magic!

It propels stocks globally – including Australia. Highly connected developed markets typically move together. The US has almost a quarter of global GDP and 69 per cent of developed world stockmarket capitalisation, giving it outsized influence. Consider: the ASX 200 and S&P 500 have a correlation of 0.66 – quite high, given 1.0 is lock-step movement and -1.0 polar opposite.

So it isn’t surprising that Australian stocks have paralleled US markets in midterm years.

Early in those years both markets wiggled sideways together – in Australia they have averaged -0.5 per cent, -2.7 per cent and -1.4 per cent, respectively, by quarter. Then? Boom! Fourth-quarter returns average 2.2 per cent, with the following Q1 averaging a whopping 7.2 per cent! The rally runs into Q2, averaging 3.0 per cent gains.

This year, the cross-Pacific boost should arrive just as Australia’s falling political uncertainty supplies your own ASX fuel. While Prime Minister Albanese’s ALP won a House majority in May’s vote, as you know, it’s a historically thin one. He needs help in the Senate from other parties. Could he make deals with the Greens being unfriendly to miners, weighing on the ASX, as many fear? Maybe – but don’t bet on it. With Russia sanctions spurring high demand for your mining and natural gas industries, domestic and geopolitical pressures will render any big climate deals difficult – as June’s emissions squabbles hint at. Tiny margins mean even a few defections could derail any big bill. As 2022 progresses, that reality will dawn more fully on investors – squashing uncertainty and spurring the ASX higher.

Remember: voters may dislike political stagnation, but stocks love it.

Whatever your views, get ready for the falling political uncertainty and higher stock prices gridlock creates.

Ken Fisher is the executive chairman of Fisher Investments.