The Midterms Could Spark a Stock Rally

President Barack Obama has already presided over the biggest stock-market rally during the start of a Presidency since Franklin D. Roosevelt in the 1930s. Now, if election year history is any guide, stocks are poised for further gains, though for reasons Obama probably wouldn't like. Should Democratics fare poorly in this fall's midterm elections and lose control of the House to Republicans, stock investors could view the resulting split government as a positive.

"Markets love gridlock," says Ken Fisher, who oversees $35 billion in Woodside, Calif., as chief executive officer of Fisher Investments. "What the markets want to see is no change: less legislation that engages in changes in taxes, spending, regulation, or property rights." The billionaire Fisher expects the market to stage a rally even before the midterm elections. Bets made on Intrade, a Dublin-based prediction market, show a 54 percent chance Republicans will take the House.

How big are the potential stock-market gains? The Standard & Poor's 500-stock index has advanced 15 percent on average in years when there was a Democratic President and Republican majority in Congress, the most of any combination, according to New York-based Strategas Research Partners.

The S&P 500 gained 6.7 percent in the 12 months after the 2006 midterm election, when Republicans and President George W. Bush lost control of both houses. In the 1994 congressional elections under President Bill Clinton, Democrats gave up their majority in the House and Senate. That was followed by the S&P's 34 percent surge in 1995, the biggest in 37 years, data compiled by Bloomberg show. The chance that Democrats will lose their Senate majority this year is 18 percent, according to Intrade.

The stock-market gains are even more impressive in the second year of a Presidency when viewed from a trough-to-peak perspective. The S&P 500 index has surged 48 percent on average starting in the second year of each U.S. Presidential term, measured from its lowest level that year through the high in the third one, according to data compiled by Bloomberg that goes back to 1928. That compares with trough-to-peak gains of 38 percent in other years.

Midterm election cycles aside, many other factors will affect the market. Corporate earnings are key, and the outlook is good. S&P 500 companies are projected to increase profits 34 percent in 2010 and 17 percent in 2011, the fastest two-year gain since 1995, based on analysts' estimates.

On the flip side, America's record budget deficits are a negative for stocks. "The U.S. is going to have to deal with its debt issues, so we see that as a constant wall that the market and economy are going to have to slowly find their way through," says Jason Pride, director of investment strategy at Glenmede, whose Philadelphia-based firm manages $18 billion. "I don't think you should make an entire investment decision on the Presidential cycle."

The bottom line: Investors seem to like gridlock: Stocks do best when there's a Democrat in the White House and a Republican majority in Congress.

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