Bob’s Journal (11/8/2018)

The markets tend to like midterm elections and divided governments, but this year could be different.

So far, stock indices have had the best rally after midterm elections in over 30 years. Should we expect it to continue?

Since 1946, after midterm elections, the S&P 500 averages a gain of 3.26% through the end of the year, according to Bespoke Investment Group. The index had a positive return following elections in two-thirds of midterm election years.

But, as I said, this year is different.

In midterm election years since 1946, the S&P 500 had positive returns from the end of September through Election Day all but four times (out of 19). The average return is 4%.

This year the market had a terrible October. From Sept. 30 through Election Day, the index declined almost 7%. The only worse midterm election year was 1978, when the S&P 500 lost 8.47% during that period.

So, while history generally says to expect stocks to rise through the end of the year, history also says the market indices shouldn’t have declined in October. This year already is an exception to the historic average.

But the good news is that in the 18 midterm election years since World War II, stocks always increased from their October lows through Dec. 31. The average return is 10%. Stocks already have had a solid return from their Oct. 29 low.

Another election statistic you’ve probably seen is that the markets do well when the two houses of Congress and the presidency are divided between the parties.

That’s true, but it’s not a good basis for making investment decisions. Instead, it is a good example of how we can play games with numbers.

First, the stock market has a positive return about 70% of the time regardless of who’s in office. So, you’re likely to find a positive return during almost any combination of party control of the presidency and two houses of Congress.

Second, the number of data samples we have is small and lacking in statistical significance. For example, there have been only five periods when we had the coming setup: Republicans controlling the presidency and the Senate while Democrats control the House.

Of these five periods, two were extreme situations. The Dow lost more than 70% from 1931 to 1933. The other extreme period was 1985 through 1987 when the Dow gained almost 62%. The result of the five periods is an annualized return of negative 1.69%.

That’s the evidence that says to expect positive stock returns in the coming months because it’s a midterm election year and we’re going to have divided government.

But it is countered by other data. For example, the market indices did poorly in October. Such poor periods tend to be followed by negative returns for at least several months.

Also, we can look at valuations, earnings growth and market technical factors to find reasons to expect lower stock market returns for a while.

I enjoy looking at the data and seeing the conclusions people draw from it. But you don’t want to base your investment strategy on limited data points, especially such small sample sets as midterm elections and divided government. Consider these only a couple of points to review when evaluating the markets.

What the data miners often overlook is that average returns don’t matter. The only returns that matter are those you earn in the current environment. Each period that makes up the average is different from the others, and usually none of them had the average return.

I remain focused on central bank policies, rising interest rates, China’s problems, the waning stimulus from last year’s tax cuts and other fundamentals. They tell me to stay diversified and limit risk.

The Data

The service sector keeps growing.

The ISM Non-Manufacturing Index declined to 60.3 from 61.6. Last month’s level was a record, so a decline was expected. But the decline was less than economists forecast. Details of the report indicated there are capacity strains in the economy.

The PMI Services Index rose to 54.8 from 53.5. New orders rose and there also were signs of capacity constraints.

Consumer credit rose less than expected and at the smallest rate in three months. Total credit increased almost $11 billion, while economists were expecting a $15 billion increase. Last month’s credit increase was revised higher to $22.9 billion. Credit card use declined for the third time in six months. The increase in credit was concentrated in automobile and education loans.

Factory Orders again offered mixed news. The headline number was a 0.7% increase. That was well above expectations and followed a 2.6% increase last month (revised upward from an initial 2.3% rise). But core capital goods increased only 0.1% after declining 0.2% last month. This is a key measure of business investment and indicates businesses have slowed purchases of new equipment.

Last week’s Employment Situation reports made clear that the labor market still is historically strong and gave more support to members of the Fed who want to continue raising interest rates. Average hourly earnings were the key factor. A 0.2% increase for the month brought the 12-month increase to 3.1%.

The JOLTS (Job Openings and Labor Turnover Survey) report also showed a strong labor market. The number of job openings declined for the first time in a while, but that’s partly because last month’s openings were revised sharply higher. Over 12 months, job openings increased by 12.5%.

The percentage of people leaving their jobs voluntarily remained at a 17-year high of 2.4%. Fed Chairman Jerome Powell has said that this is an elevated level and a precursor of wage inflation. It is another support for Fed members who want to continue raising rates.

New unemployment claims declined by 1,000. Continuing claims (people receiving unemployment benefits after the initial week) are at their lowest level since July 28, 1973. The four-week average of continuing claims is at its lowest level since August 11, 1973.

The Markets

The S&P 500 gained 3.84% for the week ended with Wednesday’s close. The Dow Jones Industrial Average rose 4.22%. The Russell 2000 produced a return of 4.92%. The All-Country World Index increased 3.81%. Emerging market equities rose 6.31%.

Long-term treasuries fell 0.69% for the week. Investment-grade bonds produced a return of 0.51%. Treasury Inflation-Protected Securities (TIPS) lost 0.21%. High-yield bonds added 1.33%.

On the currency front, the dollar fell 0.89%.

Energy-based commodities dropped 1.82% for the week. Broader-based commodities rose 0.60%. Gold gained 0.69%.

Bob’s News & Updates

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. You should sign up because I make in-depth presentations of key retirement finance topics. You can watch these online seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.

A recent five-star review of my book on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

I’m now a regular contributor to the Forbes.com blog. You can view my contributor page here.

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.