Trader’s Narrative

The mid-term US elections are finally here. Most are expecting the Democrats to keep control of the Senate and to lose control of the House to Republicans. I was curious to know what the prediction markets for the mid-term election were saying so below are the relevant charts from the Iowa Electronic Markets and intrade. And then, perhaps most importantly, what the election results mean for the stock market.

Iowa Electronic Markets 2010 US Senate Control Market:

• NRS.gain10 (blue line) will provide a payout of $1 if the Democrats have more than 60 Senate seats ($0 otherwise)
• NRS.lose10 (red line) will provide a payout of $1 if the Democrats hold fewer than 50 Senate seats ($0 otherwise)
• NRS.hold10 (black line) will provide a payout of $1 if Democrats have at least 50 but not more than 60 seats ($0 otherwise)

Iowa Electronic Markets 2010 US House Control Market:

• NRH.hold10 (blue line) will provide a payout of $1 if Democrats and Independents have more than 217 but no more than 258 House seats ($0 otherwise)
• NRH.lose10 (red line) $1 if Democrats and Independents have 217 or fewer House seats ($0 otherwise)/li>
• NRH.gain10 (black line) will provide a payout of $1 if the Democrats and Independents have more than 258 House seats ($0 otherwise)

Iowa Electronic Markets 2010 US Congressional Control Market

• NRH_NRS10 (blue line) will provide a payout of $1 if Democratic and Independent House, Democratic and Independent Senate after 2010 election ($0 otherwise)
• RH_RS10 (red line) will provide a payout of $1 if Republican House, Republican Senate after 2010 election ($0 otherwise)
• RH_NRS10 (green line) will provide a payout of $1 if Republican House, Democratic and Independent Senate after 2010 election ($0 otherwise)
• NRH_RS10 (black line) will provide a payout of $1 if Democratic and Independent House, Republican Senate after 2010 election ($0 otherwise)

intrade’s Market for 2010 US House of Representatives Republican Control

intrade’s Market for 2010 US Senate Democrat Control

intrade’s Market for 2010 US Senate Republican Control

All predictions aside, we will know soon what the ultimate outcome of the mid-term elections mean. As for their significance for the stock market, if we do see a ‘grid-locked’ government, that may not be bad at all for the future performance of equities. In fact, in the past when the US government has been so divided, the stock market has brought in some surprisingly strong returns. Here’s a chart of the permutations according to data compiled by Ned Davis Research:

A Democratic president coupled with a Republican congress is very rare in US politics. But it also results in the best stock market returns. As well, keep in mind that the mid-term election quarter within the four year election cycle is the best performing single quarter. Of course, investors start to put their chips on the table well ahead of the actual political outcome.

Currently, the market sentiment is elevated and close to excessively bullish. But seasonality continues to be positive based on both the four year election cycle as well as the annual cycle.