Unless you've been living off under a rock this year, as a reader of the Cornerstone blog, you’re aware that historical data tells us how midterm elections kick off one of the best track records you'll ever find. In fact, we’ll show you how this track record is undefeated and will likely remain so, even after all the emotionally fear driven and reactionary selling on Thursday last week in the immediate wake of the election results.
But first, last Wednesday in the afterglow of the midterm elections, the midterm rally began. Fearful heavy sellers tried to trip it up the next day, but Friday’s buying (including some outsized buying in huge fallers the previous day) began to reestablish that “cooler heads” will prevail.
Let’s cover two quick data points. First, the significant historical stock performance in the fourth quarter is in midterm election years:
Since 1928, the median fourth-quarter return in midterm years is 7.2% versus 4.6%.
Next, one thing we look for leading up to expected bull runs is whether the underlying market rotation is broadening. Through October, the broadening trade quietly surfaced under the nose of many. It’s exemplified by the equal-weight S&P 500 gaining 4.5% versus the market-weighted S&P 500, which lost over 1%:
This kind of massive spread tends to happen during overreactions, like during the April tariff announcements. Markets end up well-positioned afterwards and then tend to explode higher. The disparity occurred right as the MoneyFlows Big Money Index recovered from falling off a cliff:
And last Wednesday alone, major markets soared:
Yes, then on Thursday clear emotionally driven fear took hold over the market action but this behavior dissipated after only one day as we saw the market regain footing the very next day on Friday.
But this development shouldn't be surprising. Going back to 1990, stocks have never been lower six and 12 months after the midterm election:
This type of action historically is always supported by a broadening of the market underneath. And if we look hard enough, that’s what started at the end of October.
Last week’s reaction was historically hysterical and emotional. We firmly believe staying fundamentally constructive on equity markets makes more sense than emotional hysteria. That’s especially true taking considering the current market data and historical backdrop.
And to be clear, this analysis is still 100% applicable to the AI data center stocks regardless of the recent reactionary hijinks. There is continued strength in the data infrastructure space, and we’ll show that the current carnage in the AI buildup trade is a likely overreaction.
What Really Matters
Perhaps the writing above may seem reactionary as well. But it’s supported by facts.
Why was the huge selling last week an overreaction?
Let's start with the most important fundamental aspect of any publicly traded company – earnings earnings earnings. Since last week, earnings have continued to be historically stellar. With 78% of S&P 500 companies reporting, 87% of them beat earnings estimates:
The blended year-over-year growth rate (actuals and estimates) is 32.3%. But most importantly, the year-over-year earnings growth of actuals and estimates within the technology sector (inclusive of the AI data infrastructure trade) is 70.3%:
A handful of key headliners in the data center trade are being hit right now, but their growth is undeniable:
For those who say the growth is somewhere else in technology, it's not. Look at those data-center-specific revenue growth metrics.
We’re reinforcing these numbers because as fundamental long-term investors, it’s vital to attempt to reset our forward-looking outlooks after weeks of political noise and distractions. That’s how we get back to what really matters: corporate earnings and fundamentals.
Remember, Wall Street has historically welcomed political gridlock because it reduces the likelihood of sweeping legislative changes and creates a more predictable business environment. Increased certainty can be quickly seen via Treasury yields falling before and after the midterm elections:
Also, oil prices fell to levels not seen since August:
With the election now over, investors can turn their attention to the holiday season, which has historically been one of the strongest stretches of the year for stocks.
However, there's something much more significant driving our forward-looking optimism: corporate earnings and profits. Yes, some critics are concerned about the enormous infrastructure investments being made to support AI. Others are questioning whether the spending can continue. And now it looks like a much less supportive Congress is ahead. But the objective facts tell us that the train has already left the station.
Much of the data center development pipeline is already planned years into the future, with projects planned out to 2032. There will undoubtedly be more hearings, political debate, and haggling about electricity costs, water, etc. But new technology is already filling those holes.
Thus, there's no sign of the demand waning. The latest earnings reports prove how strong it remains.
Not to be too longwinded, but let's concentrate on a great example. AMD is one of the most important companies in the data center build-out and delivered maybe the most extraordinary growth numbers from a company of its size in history.
AMD reported revenue up 45%, with earnings up over 74%, and data center revenue up 97% to a record $8.5 billion:
And there’s more ahead. AMD’s guidance calls for Q4 revenue of approximately $17 billion, versus $13.38 billion in Q3.
The share of data center business to total revenue went from 47% to 64% in a year. And we can see similar growth from Google, Micron, SanDisk and others.
Yes, investors seem tired of paying for more data center spending. But data tells us that the spending is already paying off, even at the most extreme levels (e.g., Alphabet and Amazon).
Look at the data center revenue numbers for Alphabet, Amazon, and Intel:
- Google Cloud revenue grew 103%
- Amazon's AWS revenue grew 39%
- Intel's data center revenue jumped nearly 80%
This isn't a dead theme. This is bearish, emotional consolidation before the next bull leg higher.
While chip stocks are being tossed aside, analysts are raising their projections. Among chipmakers worth $1 billion or more, 66% have seen quarterly earnings estimates rise over the past month while only 16% have seen them fall. And yet, 82% of those same stocks are in a bear market.
Prices are falling while earnings estimates are rising.
That sounds like opportunity.
In looking at every tech company worth $2 billion or more that's growing sales at least 25% annually, there are 71 in our stock data universe. For those companies, analysts expect earnings to grow 28% next year versus 11% for the rest of the market.
These firms trade at 25 times forward earnings, so you pay less per point of growth than for the average stock by a wide margin. Three of four have rising sales estimates. Four of five beat sales estimates last quarter. And two of three are in a bear market.
If that doesn't scream that growth is on sale, I don't know what does.
Underneath the market, there’s a broadening rotation. And remember from the beginning of this post, the equal-weight index broadens before the overall market explodes higher. Rotation is what healthy markets do before the next advance. History is screaming bullish.
Since 1950, the S&P 500 has been higher a year after all 19 midterm elections, with the average gain being about 15%. Also, the trusty BMI bottomed at 22.9% on Oct. 14 and has already climbed to 42.1%.
Going back to 1990, the BMI has exited oversold during a midterm year 12 times. The S&P 500 was higher a year later every time with an average gain of 14.4%. Two years later it was higher every time by 30.2%, on average.
That's several layers of perfect records all pointing in the same direction.
So yes, the election distractions are fading and we’re about to see earnings take center stage as November's historically strong seasonality is arriving right on time.
You can worry about the headlines, or you can focus on the fundamentals.
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*Past performance does not guarantee future results.
*AMD, Google, Micron and Sandisk are owned in some CFS client accounts. Daniel Milan owns Google and Micron personally.
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