As the first half of 2022 leaves U.S. stocks on track for a historically challenging year with soaring inflation, tighter monetary policy and a possible recession, a top Wall Street analyst warned that the November midterm elections may add to the uncertainty over how this year could eventually play out.
“Historically, the third quarter has been the most volatile and only the second average decliner (along with the second quarter) in the 16-quarter presidential cycle,” Sam Stovall, chief investment strategist at CFRA Research wrote in a client note on Monday. “This year, despite a likely near-term relief rally, stocks should again feel pressure from an expected slowdown in economic activity, resulting in a reduction in EPS (earnings per share) growth projections.”
The large-cap benchmark S&P 500
has shed 18.2% year-to-date to around 3,900, but Stovall anticipated the index may bottom at around 3,500 late in the third quarter as investors “want to get rid of those stocks which they don’t want to admit that they held on to for too long” in the ending period of the fiscal year.
U.S. voters in November will go to the polls to elect members of the House of Representatives, who serve two-year terms, and roughly a third of the Senate, whose members serve six-year terms.
“When you look at the presidential cycle, going back to World War II, the worst year is the midterm election year, which has risen an average of only 5%, and is the weakest of all four,” Stovall said in a phone interview on Monday. “Midterm election years are 40% more volatile than the average volatility for the other three years.”
However, according to the note, the fourth quarter of 2022 and the first half of 2023 might be the strongest of the entire presidential cycle with a “shallower-than-expected recession, aided by declining inflation projections, and, as a result, a less hawkish Fed.”
“The third year is usually the best because the president wants to get re-elected so that they will again try to push forth economic policies that will stimulate the economy and show up in economic numbers,” Stovall told MarketWatch. “Investors are anticipators, so they buy in the third year in anticipation of the economy showing improvement in the fourth year.”
Based on the historical data which shows new bull markets typically start three months after the end of the bear and jumped an average of 40% in the 12 months after bear market bottoms, Stovall expects the S&P 500
close the year at around 4,200 and then reach 4,675 by this time in 2023.