RBC Capital Markets has reviewed how U.S. stocks performed during the second half of the last two midterm election years, 2018 and 2022, as investors assess potential risks heading into the next election cycle.
The analysis shows that both periods were marked by significant volatility, unlike the two most recent presidential election years, when equities generally moved higher.
S&P 500 Faced Similar Patterns in 2018 and 2022
In both 2018 and 2022, the S&P 500 followed a broadly similar pattern during the second half of the year.
The index reached a peak in August or September, fell to a low in October, recovered into November, and then declined again in December.
Although these moves were substantial, RBC strategist Lori Calvasina noted that the volatility eventually helped establish more durable market bottoms that held into the following year.
Elections Were Not the Only Source of Volatility
RBC stressed that midterm elections were only one factor influencing markets during those periods.
Federal Reserve policy and interest rate concerns played an important role in both 2018 and 2022. Trade tensions also weighed on markets in 2018.
In 2022, investors faced additional pressure from weakening technology earnings and the Russia-Ukraine war.
This suggests that any future midterm election volatility will likely depend on a combination of political, economic and monetary factors.
Defensive Sectors Performed Better During Sell-Offs
RBC also examined how individual sectors performed during market declines.
Consumer Staples and Health Care outperformed during the downturns in both 2018 and 2022. In contrast, Technology and Consumer Discretionary stocks generally lagged.
The pattern changed when markets rebounded.
During the recoveries, Financials, Industrials and Materials tended to outperform. Meanwhile, Communication Services, Consumer Staples and Health Care fell behind the broader market.
RBC Is Not Predicting a Repeat of Past Turbulence
Calvasina emphasized that RBC is not forecasting the same level of volatility in the months ahead.
Instead, the historical comparison is being used to assess potential tail risks and identify periods when important market turning points could occur.
The analysis may therefore provide investors with useful context without suggesting that past market patterns will automatically repeat.
Momentum Stocks Are Regaining Strength
RBC’s latest factor analysis also shows that stocks with strong price momentum have started outperforming again within both the S&P 500 and Russell 2000.
At the same time, companies with stronger earnings-per-share quality have recently underperformed.
Second-quarter earnings calls also reflected a mixed economic environment.
Companies frequently mentioned geopolitical uncertainty, inflation, supply chain pressures and weak housing turnover. However, several businesses continued to highlight strength in areas such as artificial intelligence, energy and reshoring.
Deal Activity Remains Supportive for Stocks
RBC also found that the stock market has historically tended to perform well while corporate deal activity remains elevated.
According to the firm’s analysis, more serious market problems often emerge only after the number of transactions begins to decline.
That makes merger and acquisition activity another indicator investors may want to watch when assessing broader market conditions.
U.S. Stock Valuations Remain Within Recent Ranges
On valuations, RBC said forward price-to-earnings ratios for both the S&P 500 and Nasdaq 100 currently sit around the middle of their post-pandemic ranges.
A similar pattern can be seen among the largest companies in the S&P 500.
Meanwhile, the Russell 2000’s forward P/E ratio remains close to its historical average.
RBC Remains Constructive on the S&P 500
Despite concerns surrounding midterm election volatility, RBC maintains a relatively positive outlook for U.S. equities over the next year.
Calvasina sees interest rates as the biggest risk to that outlook.
Unless recession risks increase or markets experience a significant interest rate shock, RBC expects potential S&P 500 pullbacks to remain within approximately 5% to 10%.
The firm currently gives a slight preference to Growth stocks and U.S. equities over Value stocks and international markets.
Overall, historical midterm election years suggest that investors should be prepared for periods of increased volatility. However, RBC’s analysis also indicates that market corrections can help establish more durable lows when broader economic conditions remain supportive.
