Why the stock market may skip the usual midterm election rally

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History shows that the stock market loves the period after the midterm elections – but that may not be the case following the November 8 election this year.

“A lot of things are going to drive the stock market,” Gargi Chaudhuri, head of iShares investment strategy at BlackRock Americas, told Yahoo Finance Live. “I don’t want to rely entirely on the Fed and the election alone. … But all things being equal, if you just give me a hawkish Fed and a divided government, I think it’s going to be really difficult for the equity market to reach new highs or return to the levels we had seen for maybe the second quarter of this year with this framework.”

The S&P 500 Index (^GSPC) has historically outperformed in the 12-month period following a midterm election with an average return of 16.3%, according to US Bank data. For perspective, the last time the S&P 500 produced negative returns in the year following a midterm election was in 1939.

American flags fly in front of the New York Stock Exchange, Friday, Sept. 23, 2022, in New York. (AP Photo/Mary Altaffer)

The backdrop for actions this time around remains challenging to say the least.

“I think it’s going to be very difficult for the stock market to have the rallies that we saw in the first two days of October,” Chaudhuri said.

The Federal Reserve continues its mission to crush inflation by aggressively raising interest rates. Such a hawkish policy stance by the Fed has reverberated through an array of asset markets, from the soaring US dollar to rising mortgage rates approaching 7%.

Despite impressive rallies in the first two trading days of October, the Dow Jones Industrial Average (^DJI), S&P 500 and Nasdaq Composite (^IXIC) remain mired in double-digit percentage declines for the year. Shares of big tech companies such as Meta (META) and Netflix (NFLX) each fell nearly 60% on the year as investors took profits from high-risk stocks.

Oil prices have also started to soar again, particularly after OPEC+ announced it would cut production. This has reignited a major headwind on corporate earnings.

“I think we really need to see a fundamental shift in the earnings picture where earnings growth is very healthy across all sectors,” Chaudhuri said, “and I just don’t see how that happens when we have a slowing economy because the Fed wants it to.”

Brian Sozzi is editor-in-chief and anchor at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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