Multiple ballots are held at the time of the US mid-term elections, including those at the municipal and state level, and also all the seats are up for election in the House of Representatives and a third of the seats in the Senate.
They are called “mid-term” as they take place in the middle of the four-year presidential term; in other words they take place two years after the presidential election. As such they are often regarded as a referendum on the performance of the prevailing president and his party.
In a recent article in the Financial Times, Ken Fisher described a market anomaly that he calls the 86.4 per cent miracle. According to Fisher, since 1925 returns on the S&P 500 have been positive for 67.4% of all calendar quarters, but for the 4th quarter of a mid-term election year and the two following quarters returns have been positive on average 86.4%. Fisher summarises-
midterm elections mean three straight quarters where the market rises 28 per cent more of the time than average.
What is the reason for this? According to Fisher: legislative gridlock. During electioneering campaigns politicians promise lots of radical legislation (that investors invariably dislike) to buy votes. But the reality of most mid-term elections is that the president’s party loses seats resulting in gridlock in Washington. In other words, while there is much sound and fury in the lead up to an election, it is followed by relative political calm – which investors like.
Given the high correlation of the US and UK equity markets, might this anomaly also apply to the UK?
The following chart plots the proportion of positive returns for the FTSE All Share Index for all quarters (grey bars) and those for the 4th quarter of a mid-term election (MTE) year (purple bars) and following 1st and 2nd quarters. To analyse the consistency of the anomaly over time, results are given for four different time periods.
For example, for the period 1910-2014, the FTSE All Share Index has had positive returns in 61% of all quarters, 62% of 4th quarters of a mid-term election year, 77% of the following 1st quarters, and 81% of the following 2nd quarters.
Looking at the above chart the first observation to make is that the UK market experienced a greater proportion of positive returns in the 4th quarter of mid-term election years and the following two quarters than the average for all quarters – and this applied for all four of the different time periods tested. So this was consistent with the US results quoted by Fisher.
Regarding the period 1925-2014 (the period referred to by Ken Fisher), returns have been positive in 62.1% of all quarters (this compares a figure of 67.4% for the S&P 500 quoted by Fisher), and the average for the three (MTE) quarters has been 75.8% (compared with 86.4% for the S&P 500). So, where Fisher found that the three (MTE) quarters rose 28% more of the time than the average, in the UK the equivalent figure has been 22%.
A second observation to make is that the out-performance of the 4th and 1st (MTE) quarters over the average for all quarters has markedly increased in the most recent period from 1980. And that since 1980 the (MTE) quarter with the highest proportion of positive returns has been the 4th – in fact the UK market has risen in every 4th (MTE) quarter since 1980.
The following chart is similar to the above, except that it plots the average returns instead of the proportion of positive returns. For example, since 1910, the average return of the FTSE All Share Index for all quarters has been 1.5%, for the 4th (MTE) quarter it has been 2.4%, for the 1st (MTE) quarter 6.3%, and for the 2nd (MTE) quarter 4.2%.
Generally, the same profile of performance seen above is repeated here – all three (MTE) quarters out-perform the average. Since 1925 the average return for all quarters has been 1.7%, whereas the average return for the three MTE quarters has been 5.0%.
In 2014 the US mid-term elections will be held on 4 November, while the 4th (MTE) quarter starts 1 October. Fisher predicts “glorious gridlock” and a consequent “magical melt-up” for the market.