U.S. Stock market "CORRECTION!!" Why am I not "too-skeered"

Since 1946, there have been 18 midterm elections. Stocks were higher 12 months after every single one. Every single one. That’s 18 for 18. Even though we’ve had every possible political combination in the past 72 years. Republican president with Democratic Congress. Democratic president with Republican Congress. Republican president and Congress. Democratic president and Congress.

Since 1946, stocks have risen an average of 17% in the year after a midterm. And if you measure from the yearly midterm lows, the results are even better. From their lows, stocks jumped an average of 32% over the next 12 months. For perspective, that’s more than double the average performance for stocks in all years. We’re also entering the third year of a presidential term, which is historically the strongest year for stocks.

Take a look at this chart. You can see that the performance of stocks in the third year of a presidential term beats all other years by a long shot:

Look at the chart above, and you’ll notice the second year of the presidential cycle is typically the worst for stocks. That’s the year we’re in right now — the year when midterms occur.

There’s one last important point you should know. Leading up to midterms, U.S. stocks typically perform poorly. From January to October in midterm years, they drop an average of roughly 1%. In all other years, stocks rise roughly 7% in that time frame.

Think of midterm elections like a thick fog covering markets. They obscure what the political situation will look like in the near future. Unable to see what’s coming, investors get nervous and act cautiously. Just as they would slow down while driving a car through a thick fog. Once the election concludes and the fog clears, investors regain confidence and the market gets back on track. This year is following that script to a T.

For all the market’s gyrations in the past few weeks, the S&P 500 is roughly flat this year. If we stay on script, we should expect the market to surge in November after the uncertainty of the elections is behind us.

The Federal Reserve issued a cautionary note Wednesday about risks to financial stability, saying trade tensions, geopolitical uncertainty and a buildup in corporate debt among firms with weak balance sheets pose potentially strong threats.

In what is often a boiler plate report on conditions in the banking system and corporate and business debt, the Fed instead warned of "generally elevated" asset prices that "appear high relative to their historical ranges."

In addition, the central bank said ongoing trade tensions, which are running high between the U.S. and China, coupled with an uncertain geopolitical environment could combine with the high asset prices to provide a notable shock.

"An escalation in trade tensions, geopolitical uncertainty, or other adverse shocks could lead to a decline in investor appetite for risks in general," the report said. "The resulting drop in asset prices might be particularly large, given that valuations appear elevated relative to historical levels."

The drop in asset prices would make it more difficult for companies to get funding, "putting pressure on a sector where leverage is already high," the report said.

The report further noted that the Fed's own rate hikes could pose a threat. A market and economy used to low rates could face issues as the Fed continues to normalize policy through rate hikes and a reduction in its balance sheet, or portfolio of bonds it purchased to stimulate the economy.

"Even if central bank policies are fully anticipated by the public, some adjustments could occur abruptly, contributing to volatility in domestic and international financial markets and strains in institutions," the report said.