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A Historical Perspective of Small-Cap US Stocks and Mid-Term Elections

Nov 05, 2018

 

  • Ahead of the mid-term elections tomorrow, we take a look at US small-cap stocks, as measured by the iShares Russell 2000 ETF (IWM), through the three most recent mid-term election years in 2014, 2010, and 2006 while comparing trends seen in 2018.
     
  • All three of the most recent mid-term election years saw the sitting US President’s party lose seats in the House of Representatives: in 2006, President Bush’s Republican Party lost its majority in the House of Representatives after losing 30 seats to Democrats; in 2010, President Obama’s Democratic Party lost its majority in the House of Representatives after a whopping 63 seats turned red; and in 2014, President Obama’s Democratic Party lost an additional 13 seats to Republicans in the House of Representatives, causing the legislative body to remain majority Republican.
     
  • In 2014, 2010, and 2006, small-cap stocks demonstrated a consistent trend of generating positive returns in the reminder of the year following mid-term elections: in 2014, the IWM returned 3.09% after elections on November 4th, 2014; in 2010, the IWM returned 9.35% following elections on November 2nd, 2010; and in 2006, the IWM returned 1.88% after elections on November 7th, 2006. 
     
  • Leading up to the 2018 mid-term elections, the IWM is flat on a YTD basis with returns of +0.06%. In past mid-term election years, the IWM generated returns of +1.50%, +11.39%, and +12.05% leading up to mid-term elections in 2014, 2010, and 2006, respectively.
     
  • For the month of October prior to 2018 mid-term elections, the IWM generated negative returns of –10.99%. In the past three Octobers prior to mid-term election cycles the IWM saw returns of +6.59% in October 2014, +4.15% in October 2010, and +5.88% in October 2006.
     
  • October 2018 has been by far the worst October for US small-cap stocks over the past four mid-term election years. One way that investors may interpret this is as a strong buying opportunity for small-cap stocks relative to their historical price levels leading up to mid-term elections.
     
  • If small-cap stocks keep with trends observed in the last three mid-term election years, then the IWM should generate positive returns in the remainder of 2018 following Tuesday’s mid-term election. Flat YTD returns for the IWM in 2018 paired with an October that saw the IWM’s price fall 10.99% suggest a higher upside potential for the IWM following mid-term elections than in years past when the IWM performed well leading up to mid-term elections.
     
  • Consensus analyst earnings forecast works against the idea that US small-cap stocks have higher upside this mid-term election, as consensus analyst EPS projections forecast 8.39% EPS growth over the next 3-5 years for the average constituent of the Russell 2000 Index. In past mid-term election years, analyst forecasted 3-5-year consensus EPS growth of 11.24%, 10.00%, and 11.45% in 2014, 2010, and 2006, respectively.
     
  • Further reinforcing that small-cap US stocks do not have a higher upside this mid-term election year relative to the last three mid-term election years is next-twelve-months price/earnings (NTM P/E). As of November 2nd, 2018’s close, the Russell 2000 Index maintains an NTM P/E of 21.11x, a more expensive multiple than those of the last three mid-term election years: on November 4th, 2014, the Russell 2000 Index’s NTM P/E was 20.04x; on November 2nd, 2010, the Russell 2000 Index’s NTM P/E was 18.58x; and on November 7th, 2006, the Russell 2000 Index’s NTM P/E was 20.50x.
     
  • In all three previous mid-term election years, the Russell 2000’s NTM P/E represented a cheaper multiple for a higher long-term EPS growth rate than in 2018, leading us to conclude that the US small-cap stocks are not as much of a value as they were in the last three mid-term election years. 

 

Source: Capital IQ