Mid-Term Market Moves – Part 2

Since World War II, there have been only two mid-term election years (1978 and 1994) during which U.S. equities did not experience a fourth-quarter rally. During both of these years the Federal Reserve (Fed) was aggressively hiking interest rates.
In 1978, the lead up to the Islamic Revolution resulted in strikes and unrest in Iran. In November 1978, a strike by Iranian oil workers reduced production from 6 million barrels per day to about 1.5 million barrels. At the same time, foreign oil workers fled the country. In the United States, inflation hit 9% in the fourth quarter with no signs of stopping as it approached double-digits. In response to soaring inflation pressures, the Fed was aggressively hiking rates during 1978 with 1.25% of hikes in the fourth quarter alone (the Fed ended the quarter with a policy rate of 10%).
In 1994, the S&P 500 turned in a flat fourth quarter on the heels of a shift in power to the Republicans. However, the performance was less of a reaction to the election results than to rising fears of recession amid the Federal Reserve’s aggressive hiking of short-term interest rates and a corresponding run-up in long-term interest rates (to nearly 8% from below 6% at the start of the year).
We expect the Fed will be on hold until next year, but past performance suggests a headwind for the stock market if the Fed does start to hike late this year.

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