Midterm Markets: A Most Improbable Phenomenon

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The S&P 500, that curiously-named index of 500 companies (a number arrived at, one suspects, by someone rolling a large die), has recently experienced a run of success. Three consecutive years of gains, you understand, is rather unusual. It’s happened only five times before, which, when you consider the sheer number of things that could have prevented it – asteroid strikes, global tea shortages, the unexpected reappearance of sensible shoes – is, statistically speaking, utterly improbable. Wall Street, with its unwavering optimism (or perhaps its collective inability to remember previous disasters), expects this to continue into 2026. However, there’s a wrinkle. A rather persistent, four-year cycle wrinkle known as midterm elections.

Historically, the S&P 500 tends to experience what’s politely called a ‘correction’ during these midterm years. A correction, in market parlance, is a decline of at least 10%. It’s a bit like discovering your spaceship has a minor dent. Annoying, certainly, but not necessarily a prelude to complete disintegration. The potential for volatility in 2026 is, shall we say, amplified by the tariffs imposed by a previous administration. (Tariffs, one might observe, are essentially taxes on the act of trading, which is rather like taxing the air. It works, briefly, until everyone decides to stop breathing.)

The Stock Market’s Peculiar Dislike of Midterms

Since its inception in 1957 (a year marked by the launch of Sputnik and a widespread belief in the imminent arrival of flying cars, neither of which, it turns out, were entirely reliable), the S&P 500 has consistently performed…poorly during midterm election years. The average return is a mere 1%, and the average intra-year drawdown (that’s market-speak for ‘how much your investments might lose before you panic’) is a rather alarming 18%. History, therefore, suggests a 18% dip at some point in 2026, followed by a finish roughly where you started. It’s a bit like running a marathon only to end up back at the starting line, slightly more exhausted and questioning your life choices.

Out of the 17 midterm elections since 1957, the index has entered correction territory in 12 of them. That’s approximately a 70% chance of a downturn. Not a comforting statistic, but then again, comforting statistics are rarely accurate. Why this happens? Midterms introduce uncertainty. The ruling party invariably loses seats, leading investors to ponder the future of fiscal, trade, and regulatory policies. Financial markets, it seems, are deeply averse to pondering. They prefer things to be predictable, which, in the grand scheme of things, is a rather unreasonable expectation.

However, this uncertainty tends to dissipate rather quickly after the election, and stocks often rebound. Carson Research suggests the six months following a midterm election (November through April) are the strongest of the four-year presidential cycle. The S&P 500 has added an average of 14% during those six months. This is either a sign of remarkable market resilience or a collective case of short-term memory loss. It’s difficult to say.

Some investors, naturally, are tempted to sell everything now and buy it back later. This, however, is akin to attempting to predict the behavior of a particularly erratic butterfly. It rarely works. Peter Lynch, a rather astute fund manager, once warned that far more money is lost trying to time the market than is lost in market corrections. A lesson often ignored, naturally.

The S&P 500 has performed well during some midterm years. It’s returned as much as 38% and delivered double-digit returns around 40% of the time. But predicting the future is, as anyone who’s tried it will tell you, remarkably difficult. Wall Street expects 2026 to be relatively good, buoyed by artificial intelligence spending and the potential for lower interest rates. But relying on such predictions is a bit like navigating by the stars using a faulty telescope.

Wall Street’s Optimistic Projections (and Their Inherent Flaws)

Currently, Wall Street analysts have over 12,800 ratings on stocks within the S&P 500. FactSet Research combines these ratings to create a ‘bottom-up’ forecast for the index. This methodology suggests the S&P 500 will reach 8,146 in the next year, implying a nearly 17% increase from its current level of 6,976. A substantial increase, certainly. But remember that Wall Street’s forecasts are often…optimistic. During the past four years, their median year-end forecast has been off by an average of 16 percentage points. It’s a bit like aiming for the moon and landing in the next county.

S&P 500 companies have reported accelerating revenue and earnings growth, and Wall Street expects this trend to continue. But if these expectations aren’t met, the market could decline sharply. This is especially true given the current valuations. The S&P 500 trades at 22.2 times forward earnings, a premium to the five-year average of 20 times. This suggests that investors are already pricing in a considerable amount of optimism. A dangerous game, naturally.

The big picture, therefore, is this: Wall Street anticipates a strong performance from the S&P 500 in 2026, but midterm election years have historically involved market corrections. Investors should mentally prepare themselves for this outcome. Limit stock purchases to your highest-conviction ideas. Sell any stocks you would feel uncomfortable holding through a downturn. And consider building a cash position in your portfolio. (Cash, of course, is simply a socially-accepted token representing future goods and services. A rather curious invention, when you think about it.)

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2026-02-04 12:02