Guest commentary: Sifting data from midterm elections past

They’re back — those ads telling us how bad the other guy is, highlighting the opponent’s poor performance record, yet telling us nothing about their own qualifications for the job. You guessed it. I’m talking about political campaign ads. Mid-term elections are a just a few weeks away, and our favorite television programs are being interrupted with these uninformative ads.

But these elections are important, and in my opinion the race worth watching in the mid-term elections this year will be in the Senate. At this early stage it appears there is a slightly better than 50-50 chance that the Republican Party will win control of the Senate. As for the House, the Republican majority does not appear to be changing hands.

Currently, Democrats control the Senate with 53 seats and two Independents that both caucus with the Democrats. Republicans hold the remaining 45 seats.

So according to our political analyst at UMB, George Hersh Jr., here’s the math that leads us to our conclusion that the Republicans have the edge this time. This year there are 36 seats being contested — 21 Democrats and 15 Republicans. Seven of the Democrats are in states that supported Mitt Romney in the presidential election and in these states, the president’s approval rating is substantially lower than the national average. Only one of the Republicans up for re-election is in a state that President Barack Obama carried.

Historically, incumbency is a powerful thing. During an average election cycle, 90 percent of incumbents win re-election. The Republicans need six additional seats to have the majority, which means it’s going to be close and is why we put the odds at only slightly better than a coin toss.

What we find interesting is looking past the 2014 Senate race and into the 2016 cycle where we see the opposite happening. Twenty-four Republicans are up for re-election and seven are in states that supported the president, meaning the Senate may see a yo-yo effect.

So what does it matter if the Republicans control Congress? If they are in control, we believe Congress will focus its attention on a few major issues:

▪ Spending and other fiscal issues. The debt ceiling will once again be a discussion point in March of 2015. A Republican-controlled Congress may look for spending concessions.

▪ The 2016 budget. The Republicans made a big deal out of the Senate’s failure to pass a budget in the past, so now it would be their turn to get it done. If Paul Ryan is chairman of the Ways and Means Committee, we could see discussions around tax reform and changes to Medicare and Medicaid.

▪ Immigration reform. This could be delayed to make it a presidential election year issue.

Other issues the Republicans may take on could include changes to the Affordable Care Act and Dodd-Frank legislation.

Perhaps the most pressing question on investors’ minds regarding the mid-term election is what it will do to the markets. Historical data tells us that mid-term election years are historically poor performing years in the stock markets.

Analyzing 142 years of data we found that the second year of a president’s term is the worst performing, posting an average return of 2.7 percent. The best year is the third year, with equity markets gaining on average 12.3 percent. One possible reason for the poor performance in the mid-term year could be that policy makers remove stimulus after a presidential election, with the worst of the restrictive policy in year two.

But we looked deeper at the data, focusing not on this as Obama’s second year in a term, but rather his sixth year overall. The data sample is smaller because not all presidents win re-election, but analyzing the returns in year six paints a very different picture. Looking at Wilson, Roosevelt, Eisenhower, Nixon, Reagan, Clinton and George W. Bush, we find that year six boasts an average return of more than 14 percent, with only one down year (Nixon). One can only guess why, but perhaps the president is focused on different issues, non-election priorities or legacy issues, in the second term.

I have heard many complain that having a Democrat in the White House is bad for business. That may or may not be accurate, and people have a right to their own opinions. But on the assumption that stock market returns are a proxy for business conditions, it isn’t the case. Going back to 1901, using the Dow Jones industrial average as a barometer, the best-performing markets have occurred with a Democratic president. Further, the average return under a Democratic president is 7.9 percent versus 3.0 percent with a Republican president.

What if we are correct and the Republicans control Congress the last two years of the Obama presidency? What can we expect from the equity markets? Historically that separation of control produces the best returns in the Dow. The average return in that scenario has been 9.8 percent. You might be interested to know that the worst returns — 1.7 percent — have been seen when you have the Republicans in total control of Washington.

Perhaps our founding fathers set it up that way to ensure no one party should have total control, at least not for long. Perhaps the financial markets don’t like abrupt changes and uncertainty. Gridlock ensures nothing will get done quickly and any policy tweaks will be relatively small.

We cannot disagree with data, but keep in mind that elections do matter on many fronts. So find a way to tolerate all those campaign ads and go out and exercise your constitutional right and vote. If there’s any silver lining to having your political party in control of one side and your opposing party the other, remember it may be a good thing for the financial markets.

This story was originally published September 29, 2014 at 11:44 PM with the headline "Guest commentary: Sifting data from midterm elections past."