The Stock Market Will Make a Big Move in the Next 6 Months if History Repeats Itself
Year to date, the broad-based S&P 500 (^GSPC -0.51%) has added 10%, while the growth-centric Nasdaq Composite (^IXIC -1.07%) has added 9%. The driving force behind those gains has been strong corporate earnings growth, which itself has been fueled by enthusiasm for artificial intelligence.
Indeed, FactSet Research estimates S&P 500 companies will report nearly 33% earnings growth this year, the fastest growth outside of a post-recession recovery in over three decades. And Goldman Sachs analysts argue the AI investment boom is driving nearly half of that growth, though they expect its contribution to fade going forward.
However, there is some good news for investors. A stock market catalyst seen just once every four years is about to resurface, and it portends substantial upside in the coming months. Here are the important details.
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The stock market tends to rocket higher after midterm elections
Midterm elections tend to create substantial stock market volatility, so much so that they have generally been the worst years of the four-year presidential cycle. There is a simple explanation: policy uncertainty.
To elaborate, the political party in the White House has historically lost seats in Congress, with the average turnover being 24 House seats during midterm election years dating back to 1958. Investors can’t be sure how the congressional shake-up will impact the president’s fiscal, regulatory, and trade policies, so they sell stocks until they get more clarity.
In turn, the S&P 500 has suffered an average peak-to-trough decline of 18% during midterm election years, far exceeding its average loss in other years. However, there is a big silver lining for investors: The stock market has historically recouped its losses quickly.
Indeed, the six-month period post-midterm elections has historically been the strongest six months of the four-year presidential cycle, with the S&P 500 returning an average of 13% since its creation in 1957 and the Nasdaq Composite returning an average of 18% since its creation in 1971. Importantly, both major indexes have always produced positive returns during the six-month period post-midterms.
So what? Midterm elections take place on Tuesday, Nov. 3. History says that, regardless of how the election unfolds, the S&P 500 will increase 13% to about 8,610 over the next six months. Meanwhile, history says the Nasdaq Composite will increase 18% to about 30,200.
Wall Street expects the S&P 500 to advance 22% in the next year
Investors should never lean too heavily on stock market forecasting tools. Past results are never a guarantee of future returns because every situation is different. In this case, the S&P 500 has never been this expensive headed into midterm elections as measured by its cyclically adjusted price-to-earnings (CAPE) ratio.
The S&P 500 currently has a CAPE ratio of 40.7. Excluding the last few months, U.S. stocks have not been that expensive since the dot-com crash in 2000. That was not a midterm year, but the S&P 500 has historically performed poorly when starting from such a high valuation. Following incidents where the index’s monthly CAPE ratio topped 40, it has fallen by an average of 3% during the next year
Nevertheless, Wall Street remains extremely bullish on the U.S. stock market. The S&P 500 has a median 12-month target price of 9,328, according to FactSet Research. That implies 22% upside from its current level of 7,620.
Analysts are most optimistic about stocks in the communication services and technology sectors, which are projected to return 39% and 28%, respectively, over the next year. They are least optimistic about stocks in the energy and healthcare sectors, which are forecast to return 6% and 5%, respectively.
Source: www.fool.com — article syndicated from the publisher’s feed; all rights remain with the original publisher.