The Bank of Canada’s rate hikes, galloping inflation despite plunging housing prices, fading commodity tailwinds – these and more have commentators shrieking recession looms, dooming the TSX. Think again. Why? An unfathomed catalyst should soon bring sweet relief: November’s U.S. midterm congressional elections. Those raucous contests that voters hate deliver a form of Canadian stock market magic – gridlock – and it brings do-nothing governments, which stock markets love. Particularly in Canada. Let me show you how and why.
Americans routinely squabble over whether Democrats or Republicans are “better” for stocks and the economy – like Canadians do for Canada’s main parties. That is mostly theatre. Stocks don’t actually prefer any party. Their chief political concern is big, controversial legislation. Why? Big bills always create winners and losers. Behavioural psychology shows people hate losing money or property rights hugely more than they like winning. Big legislation complicates business planning, too.
Hence, uncertainty rises when big bills pass or even garner serious consideration – consider the hubbub the online streaming bill is already drumming up. Gridlock ends that. Knowing rules won’t change much, businesses and investors more confidently deploy long-term capital. Stocks love that. In America, gridlock entails the White House being of a different party from one or both chambers of Congress.
Since 2021, razor-thin margins let President Joe Biden’s Democrats pass big spending and regulatory bills. November’s midterms should squash that. Consider: Democrats’ nine-seat House of Representatives edge is historically tiny. All 435 House seats are up in November, and the sitting president’s party routinely loses seats to the opposition party. Presidents who have below average popularity, like Mr. Biden, lose 38 seats on average. Mr. Biden’s approval rating remains just 42 per cent – weak historically. Republicans likely gained too many vulnerable seats in 2020 to flip 38 this time. But they should easily win enough to gain House control. Note: The party in control of either chamber dictates fully, 100 per cent, which bills get voted on and which don’t.
The Senate? Democrats’ present edge is the smallest possible – a 50/50 split with Vice-President Kamala Harris breaking ties. Thirty-five seats are up. Republicans netting just one would flip control. But only a handful of races are in doubt. So anything could happen. Regardless, a House flip by itself brings formal gridlock – reliable bull market fuel.
The proof? Since 1925, the S&P 500 has been flattish in midterm years’ first three quarters (in U.S. dollars), as candidates motivate their bases with big promises and hot rhetoric, roiling sentiment. But as Election Day nears, stocks begin pre-pricing gridlock. Hence U.S. stocks average 6.3 per cent gains in midterm years’ fourth quarters, rising in 83.3 per cent of them.
That rally rolls on: Returns average 6.6 per cent and 5.5 per cent in the ensuing two consecutive quarters, with 87.5 per cent of each positive. Midterm magic! Hence, there hasn’t been a negative third year of a president’s term since 1939 – and it was only down 0.9 per cent.
This midterm effect spills worldwide, including Canada. The S&P 500 and S&P/TSX Composite have a 0.81 long-term correlation – strong, given 1.0 signals lockstep movement and minus 1.0 the polar opposite. Since 1970, Canadian stocks averaged quarterly declines of 1.6 per cent in U.S. midterm years’ first three quarters (in Canadian dollars). But the fourth quarter brings 5.1 per cent average gains, with 76.9 per cent of quarters positive. The following two quarters average 7.6 per cent and 4 per cent gains, respectively, with 92 per cent and 70 per cent of them positive!
Europe and Asia experience similar U.S. midterm mojo. While markets get hip to most patterns, eroding their influence, political biases make investors reject this trend’s reality.
This year, think globally to fully capture the effect. Why? Energy and utilities are the only two world sectors that are up year-to-date through Sept. 20. Their 23.5 per cent share of TSX market capitalization is buoying 2022 Canadian returns. Your huge financials sector, another outperformer, also helped. But typically areas that fall most in downturns lead the next recovery. That means big tech and growth stocks – largely lacking in Canadian markets despite Toronto’s nascent tech hub status.
To increase the chances you capture the effect, just days away now as the fourth quarter starts, look to America for tech and consumer discretionary stocks. They were big 2022 laggards. Target tech-like interactive media and services stocks within communication services, too – they’re down 34.6 per cent. Those areas comprise 43.3 per cent of U.S. market cap versus the S&P/TSX’s 8.9 per cent. And seek big European luxury goods firms, particularly France’s and Switzerland’s.
Could Mr. Biden’s Democrats pull off a November sweep, thwarting gridlock? Maybe – but current polling makes that extraordinary midterm outcome unlikely. Don’t wait for midterm magic’s probability to become reality. Position now to ride the gridlock gravy train.
Ken Fisher is founder, executive chairman and co-chief investment officer of Fisher Investments.