Opinion: Midterm election may trigger market swings

They’re back ... those ads telling us how bad the other guy is, highlighting their poor performance record, yet telling us nothing about their own qualifications for the job. You guessed it – I’m talking about political campaign ads.

In my opinion, the race worth watching this year is in the Senate. At this early stage, we believe there is a slightly better than 50/50 chance the Republican Party will win control of the Senate.

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

According to UMB Bank political analyst George Hersh Jr., here’s the math: This year, there are 36 seats contested. Seven of the Democrats are in states that supported Mitt Romney in the presidential election and in these states, President Barack Obama’s approval rating is substantially lower than the national average. Only one of the Republicans up for re-election is in a state Obama carried.

During an average election cycle, 90 percent of incumbents win re-election. The Republicans need six additional seats to have the majority, meaning it’s going to be close.

Looking into the 2016 cycle, we see the opposite happening. Twenty-four Republicans are up for re-election, and seven are in states that supported Obama, 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:

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

2. 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’s their turn to get it done. If Rep. Paul Ryan, R-Wis., is chairman of the Ways and Means Committee, we could see discussions around tax reform and changes to Medicare and Medicaid.

3. Immigration reform. This could be delayed to make it a. election-year issue.

4. Other issues. The Republicans may take on changes to the Affordable Care Act and perhaps Dodd-Frank legislation.

Perhaps the most pressing question on investors’ minds is what it will do to the markets. Historical data tells us midterm election years are historically poor performing years.

Analyzing 142 years of data, we found 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 year could be that policy makers remove stimulus after a presidential election, with the worst of the restrictive policy in year two.

I have heard many complain that having a Democrat in the White House is bad for business. That may or may not be accurate, but everyone has a right to his or her own opinion.

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 percent with a Republican president.

What if we are correct and the Republicans control Congress with Obama in the White House – then 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 the worst returns – 1.7 percent – have been seen when the Republicans in total control of Washington.

K.C. Mathews is a chartered financial analyst and executive vice president and chief investment officer of UMB Bank in Kansas City. The bank operates two Springfield branches.[[In-content Ad]]