Last week’s midterm elections delivered plenty for investors to digest, as evidenced by the market’s recent volatility.
But now that the results are in, it’s time to look past the political headlines and refocus on the things that tend to matter most for stocks over time: interest rates, earnings and economic growth.
History suggests that’s usually the right call if you want to be on the right side of the post-election trade.
According to J.P. Morgan Global Research, the S&P 500 has gained an average of 13.7% in the year following midterm elections. Following elections that resulted in divided government, like this one, the average gain has been even better at 15%.
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Of course, historical averages can’t guarantee what will happen this time around. But they offer a useful reminder: Political uncertainty often feels more significant in the moment than it ultimately proves to be for stocks.
After Monday’s rally, investors appear increasingly ready to move on.
The major indexes all surged more than 2%, with S&P 500 gainers outnumbering decliners by nearly six-to-one. The S&P 600 SmallCap Index gained nearly 3%, with every sector participating in the rally.
So, what matters now?
The Post-Midterm Market Trends I’m Watching Now
I’d put interest rates near the top of the list.
A December Fed Hike Is Almost a Done Deal
The Fed raised rates in September, then held in October. The CME FedWatch Tool now implies a 99% probability of another hike at the December 9 meeting.
That doesn’t leave much room for debate, especially given what Fed members have said lately.
Fed Governor Christopher Waller supported a 25-basis-point December increase yesterday and even raised the possibility of a larger 50-basis-point move if inflation remains hot.
Normally, that might sound like bad news for stocks.
But one encouraging development is that the 10-year Treasury yield, which has been a significant problem for the market over the last couple of months, is no longer moving relentlessly higher.
The 10-year climbed from around 4.5% this summer to a peak near 5.36% in early October. Since then, it has retreated to around 4.86%.
That matters, particularly for small caps.
Small Caps Could Use a Break from Higher Yields
I’ve written extensively this year about small caps’ sensitivity to interest rates.
Smaller companies generally have fewer financing options and greater exposure to floating-rate debt than their larger counterparts. So when the 10-year surged above 5%, small caps took it on the chin.
The S&P 600 hit an all-time high around 1,832 in August, then fell 10.5% to roughly 1,638 in October as long-term yields surged.
As the 10-year has retreated, small caps have been recovering. The post-midterm selloff last Thursday interrupted the trend, but Monday’s nearly 3% gain pushed the S&P 600 back to around 1,722 and helped it recover most of the election-related decline.
This doesn’t mean small caps are suddenly off to the races. But the relationship between small caps and long-term interest rates is absolutely worth watching.
A December Fed hike is nearly fully priced in. If the market can absorb it while the 10-year remains well below its recent highs, that would provide more relief from one of the biggest pressures on smaller companies.
Earnings Are Still Doing the Heavy Lifting
There’s another reason to focus on rates and fundamentals rather than trying to tease apart every headline coming out of Washington.
Earnings remain extremely strong.
Forward earnings for the S&P 500, S&P 400 MidCap and S&P 600 SmallCap indexes all recently reached record highs. And Q3 S&P 500 earnings are now on track to grow nearly 26% from a year ago.
In other words, last week’s election-related volatility did not coincide with deteriorating earnings expectations. Quite the opposite.
Sure, there are legitimate questions about how the midterm results could affect everything from taxes and regulation to the AI infrastructure buildout. J.P. Morgan, for example, sees potential new headwinds for data-center development and power infrastructure in certain areas.
But the broader economic outlook remains largely unchanged following the election. So while the composition of Washington has changed, the basic investing landscape has not.
Earnings are strong, long-term interest rates are moving in the right direction, small caps are recovering, large caps historically do well following midterms and the market has already priced in another Fed hike.
That’s what matters now.
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