Mid-term election years are often a struggle for small-caps but not always. In our 2024 Year End Letter we noted the R2000 had been up 100% of the time in Post-Presidential election years – and ’25 likely will uphold that trend. Mid-term election years are a different story, however, averaging only 0.5% and rising only 45% of the time. Mid-term Election years have also proven difficult for R2000 relative returns, accounting for some of the R2000’s worst relative performance years—which is not something small-cap investors want to hear after lagging large-caps for a likely fourth straight year. But there have been some good mid-term election years mixed in with the bad, and we argue that could be the case in ’26.
The last two mid-term election years have been terrible for small-caps. The R2000 has fallen the past two mid-term election years in ’22 and ’18 and has declined in six of eleven mid-term election periods. Eight of eleven have posted negative or below average returns. The R2000 has also underperformed during the past three mid-term election years in ’14, ’18 and ’22. But there have been some good years too, notably ’82, ’06, ’10. Can ’26 buck the trend and be one of the rare good mid-term election years?
What commonalities does ’26 have with the R2000’s strongest mid-term election annual returns in ’82, ’06 and ’10? Perhaps the connective tissue for these three years and ’26 is a shift toward fresh or additional monetary easing. The economy was heading toward the ’81-’82 recession with Volcker era interest rates easing from their ’81 20% high to 8.5% by year-end ’82. In ’06, the Fed culminated its two-year systematic hiking cycle that took rates from 1.0% to 5.25% ending Jun ’06. In late ’10, the Fed announced QE2 on top of already running ZIRP (“Zero Interest Rate Policy”) since Dec ’08. Fiscal policy was also fairly accommodative during those years with the Reagan tax cuts and increased defense spending taking effect in ’82; ’06 added Medicare Part D coverage to the existing outlays from the Bush tax cuts and War on Terror; ’10 extended the Bush tax cuts, cut the payroll tax and extended unemployment benefits. Politically, ’82 reduced the Reagan majority while ’06 and ’10 witnessed Congressional power changes in at least the House where divided government is often treated benignly by markets. While no correlation is perfect, the types of events that occurred in ’82, ’06 and ’10 are not all that dissimilar with what ’26 could look like with further Fed easing (stoked further by a new Fed Chair as Powell enters ’26 as a “lame dove”), increased fiscal outlays from the OBBB (“One Big Beautiful Bill”) and existing $2T deficits and a political environment where elections by the likes of Mamdani in NYC and VA and NJ Democratic gubernatorial victories argue the Republican House majority is in jeopardy. In sum, monetary policy, fiscal spending and the political landscape set for ’26 are highly analogous to ’82, ’06 and ’10 when small-caps put on some of their strongest mid-term election years historically.