The stock market is poised for a Santa Claus rally as midterm elections tend to juice returns, Ed Yardeni says

Ed Yardeni, president and chief investment strategist of Yardeni Research, on April 30, 2015

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• The stock market is poised to experience a Santa Claus rally into year-end, according to Ed Yardeni.
• Yardeni believes the midterm election will spark a strong rally that could last for months.
• "Midterm elections no matter what have a tendency to be very bullish," Yardeni said.

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The upcoming midterm elections could spark a Santa Claus rally in the stock market that extends into next year, according Ed Yardeni of Yardeni Research.

In a note to clients late last month, Yardeni highlighted that midterm elections have been "consistently bullish" for the market, leading to average upside S&P 500 gains of 0.5%, 0.6%, and 1.4% in the months of October, November, and December, respectively.

The gains are even stronger when you look out longer-term. Based on historical data analyzed by Yardeni, since 1942, the S&P 500 has delivered average three-month, six-month, and 12-month gains post-midterm election of 7.6%, 14.1%, and 14.9% respectively. 

"We concluded: 'Yes, Virginia, there really is a Santa Claus rally. Apparently it tends to be even more likely during midterm election years," Yardeni said. 

But historical data is not indicative of future returns, and investors have a lot to deal with that may not have been present during prior year-end rallies. Inflation is consistently coming in at four-decade highs, the Fed is on a path aggressively hike interest rates by more than 400 basis points this year, and consumers are getting squeezed by wage growth that is not keeping pace with the broader rate of change in prices.

On top of that, the Fed is beginning to reduce its near $9 trillion balance sheet by rolling off $95 billion worth of treasuries and mortgage backed securities per month.

But Yardeni says the market already knows all of this. 

"The market knows they're [Fed] going to do 75 basis points. Now the market is only confused about 50 versus 75 basis points in December," Yardeni told CNBC last month. "I think what the market is looking for is a pause, I don't think they're looking for a pivot. They're looking for a pause. The Fed has been awfully aggressive."

And the economy is holding up just fine, with third-quarter GDP beating expectations and the labor market remaining resilient. New job opening in September climbed by nearly half a million. Yet that sets the Fed up for a more hawkish stance as they try to tame inflation by slowing down the economy. And stocks don't like a hawkish Fed.

"The main bearish theme for stock investors this year has been the old adage: 'Don't fight the Fed,' especially when the Fed is fighting inflation. However, the market may be starting to anticipate a red wave in the mid-term congressional elections and a rapidly approaching terminal federal funds rate. Perhaps, another old adage is about to play out: 'Don't fight Santa Claus after mid-term elections," Yardeni concluded.

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