Stocks have gained in the year after every midterm election since World War II - and investors can expect that run to continue even as the Fed keeps hiking rates

• The S&P 500 is likely to extend a historic run of positive returns after midterm elections, market strategists say.
• The S&P 500 in has posted positive returns in the 12 months after midterm elections since the end of World War II.

A historic run of positive returns for stocks following midterm elections in the US is likely to remain intact even as investors face the challenge of a hawkish Federal Reserve that's determined to cool down scorching inflation, market analysts say.

Democrats' control of Congress is in question with the November 8 midterms, with all 435 seats in the House of Representatives and 34 of the Senate's 100 seats on ballots across the country.

One historical certainty is the S&P 500's performance 12 months after a midterm election. The broad equity index has posted positive returns after each mid-term since 1946–after World War II ended in September 1945.

The S&P 500 is entering this year's electoral contest in a bear market, down roughly 20% from its all-time closing high of 4,796.56 reached in early January. Stocks have been hammered by a quick ascent in borrowing costs, with the Federal Reserve aggressively raising interest rates to pull inflation down from a four-decade high.

The central bank is poised to deliver even more rate hikes that could push up its benchmark lending rate to 5% or more next year, driving fears of a looming recession. Still, there's hope for the stock market if history is any guide.

"We think the stage is still set for a pretty substantial end-of-year rally," Ryan Detrick, chief market strategist at investment firm Carson Group, told Insider. Looking at seasonality, October is the strongest month of a mid-term year followed by November and December, on average. The S&P 500 has, on average, posted a positive return of 14.1% in the 12 months after mid-term contests, he said.

"It's not abnormal to see mid-term years struggle early and then see strength late. Once we can get past the uncertainty of the election … that could just be one more catalyst, one less thing for the market to worry about - and there are a lot of things to worry about," he said.

High on the list of worries for investors is inflation. The CPI report for October is due on Thursday and economists polled by Bloomberg generally see just a slight edge downward in core and headline inflation, to 6.5% and 8%, respectively. Fed Chairman Jerome Powell said last week it's still "very premature" for policymakers to consider pausing rate increases and that the path to a soft landing for the economy has "narrowed."

The S&P 500 will likely hold onto its run of positive post-mid-term returns but the gain for 2023 may be limited, Keith Lerner, co-chief investment officer at Truist Advisory Services, told Insider.

"Historically, there tends to be a lot of stimulus right as you move into a third year of a presidential cycle, which is part of the reason why markets have gone up 100% of the time 12 months later," Lerner said. "But I will tell you we are not looking for monetary stimulus or fiscal stimulus next year. The best thing going for the market is that the starting points have corrected a lot," he said.

The S&P 500 has come off its bear-market lows. Its October gain of roughly 8% - the best October performance ever - helped lift the index from around 3,573 to 3,845 by midday Tuesday.

'Floor of support'

The Fed was tightening monetary policy in the midterm years of 1946, 1958, 1994, and 2018, and stocks over those next 12 months posted total returns averaging 12.8%, Sam Stovall, chief investment strategist at CFRA, told Insider.

He said heading into the year-end it appears that the S&P 500 has found a "very strong floor of support," at 3,500.

"If we get a Santa Claus rally, it will be because the market once again is anticipating that the Fed will ease off of the brake and raise rates by 50 basis points in December," Stovall said.

Stovall said stocks could also draw support from investors anticipating two smaller-sized rate hikes in 2023 of 25 basis points each. The move could bring the fed funds rate to a peak between 5% and 5.25%.

Detrick said his team is optimistic that inflation has peaked.

"That could also allow the Fed to be a little less hawkish," he said. "We'd be optimistic that can be a real positive for the stock market," he said. Detrick said dovish signals from the Fed could leave the S&P 500 in 2023 with a higher post-midterm election return than the 14.1% average he had found.

Stovall said stocks have risen in price 84% of the time in the fourth quarter of election years. Of course, nothing is guaranteed when it comes to market action, he said.

"We've got to realize that history is a great guide, but it's never gospel," Stovall said.