Will a GOP Victory Give the Stock Market Wings?

The election is still a week away, but already Wall Street gurus and Las Vegas bookies are trying to calculate how much the outcome will affect the stock market. If Republicans win control of Congress, will that send stocks skyrocketing higher? What will happen if there's no clear judgment? Or maybe it'll turn out that, as in previous midterm years, the election results don't matter to stocks as much as the economic news does.

Jeffrey Hirsch, editor-in-chief of the Stock Trader's Almanac, says the average stock market return in midterm election years is a paltry 4%. But he notes that it's in the following year of a presidential term that there's an uninterrupted history of big gains.

Since 1914, Hirsh says, the stock market has gained an average of 50% from the market low in the midterm year to the market high in the year before the presidential election. Why? Presidents tend to prime the economic pumps when they're running for reelection.

Can the Republicans Take Both Houses?

Hirsch adds that the market does best when the president is a Democratic and the Republicans control Congress, though the prospect of that happening is still far from a sure thing at this point. "I'm not convinced that we're going to get a Republican-controlled Congress. I think the jury is still out on that," Hirsch says.

An NBC News/Wall Street Journal poll released Oct. 21 said 50% of likely voters wanted a GOP-controlled Congress, versus 43% who said they want the Democrats to remain in charge. While pollsters say it's likely that the Democrats will lose control of the House, the race for the Senate is still up in the air. At this point, it seems improbable though not impossible that the Republicans will sweep the upper house. The Democrats currently have a 59-41 majority in the Senate.

Wasif Latif, vice president of equity investments at San Antonio, Texas-based USAA Investment Management, which has $45 billion is assets, says there may be an equity sell-off after the election because the market has already priced in a Republican victory.

"It may be a case of buy the rumor and sell the news," Latif says, "meaning that by the time the actual results come out, a lot of the advantages would have been priced in, and people would be looking to take profits at that point."

Complicating Factors

Among those benefits, the Republicans are perceived to be less likely to raise taxes for such things as capital gains on stock market profits. That could boost equities because investors would be more likely to invest there rather than in bonds, where they would have to pay the full tax rate on any income.

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Another factor complicating a market prognosis for this year's election is the fact that the Federal Reserve's interest rate setting committee meets at the same time as the voting is taking place. It's widely expected that the Fed will decide to buy more Treasury bonds and mortgage securities, a process known as quantitative easing, which is designed to force interest rates down in an effort to stimulate the economy.

Fed Chairman Ben Bernanke has made it clear that another round of quantitative easing is likely because of the country's high unemployment rate. But the stock market has already enjoyed a sharp rebound in September in anticipation of more easing because financial assets tend to go up when market liquidity rises. The Dow Jones Industrial Average is up 6.62% so far this year.

"Unless there's a continued element of positive surprise, the market has already been stoked and has gone up quite a bit, so it needs to be fed continuous positive surprises in order to continue to go up," Latif says.

"Primed for a Bit of Retrenchment"

Hirsch has studied past examples of midterm years that had gains in September and found that they came after the year's low was already in place. After those past elections, the market rallied quite substantially: On average it went up 46% in midterm election years when a positive September surprise took place.

"I think we're primed for a bit of retrenchment right here, but I don't think it's going to be severe," Hirsch says. "Having a positive September is a good indication that the worst is behind us."