Wall Street is largely bullish about market trends next year, but the midterm elections could put a damper on that positive outlook. There are already plenty of eventful triggers in the coming months, including a new Federal Reserve chair and an expected Supreme Court ruling on the legality of President Donald Trump’s tariffs. A partial U.S. government shutdown could also play a role if disagreements between Democrats and Republicans in Congress over extending key Affordable Care Act (ACA) subsidies persist. The market could become even more turbulent if the 2026 election comes into play. “Given how polarized the political climate is in this country, this is just another factor that adds to the potential volatility in the market,” said Eric Sterner, chief investment officer at Apollon Wealth Management. Historic Underperformance Over four-year presidential cycles, midterm election years tend to be the most volatile for stocks, with the S&P 500 averaging a 19% annual decline, according to Aptus Capital Advisors. The average annual drawdown for all four years is 16%, while the average annual decline for the other three years is only 12%. “Sentiment is going to be more volatile than the market. Obviously, (Washington) has a lot to navigate in 2025: tariffs, corporate taxes, personal taxes, geopolitics,” David Wagner, the firm’s head of equities, told CNBC. “But we’ll start to see whether these policies have any impact during the midterm elections.” Wagner said the first six months of stock returns tend to be particularly low in midterm election years because the stock market is “very good at pricing in higher growth before it actually takes off.” When growth actually takes off and government bond yields rise, the market often shows a “larger-than-average intra-year drawdown.” He added that at this level of volatility, the market favors more defensive sectors, noting that healthcare has had the best interim performance compared to other sectors going back nearly 30 years. The other two top performers are consumer staples and utilities. Given the potential impact on the ACA market, Wagner believes that while further government shutdowns could further complicate the health care industry’s performance, the broader market will eventually be able to weather the outage. “Markets should be able to ignore a government shutdown, even in a midterm election year, because this is a financing issue, not a debt ceiling issue,” Wagner said. “It’s just a mechanism to try to figure out what to fund, the diversion of funds, but a debt ceiling issue could involve an overall debt downgrade by the credit agencies, and that’s what historically scares markets.” The ‘Sweet Spot’ Much of the pressure on markets in midterm election years occurs in the first three quarters of the year. Raymond James’ Ed Mills told CNBC that part of the reason is uncertainty about how the makeup of Congress will change after the election. However, things could start to turn around in the market in the final quarter of 2026. “Typically around October of a midterm election year, the market tends to kind of turn around and turn positive and start going up,” said the Washington policy analyst. The “sweet spot” of the four-year cycle, from the fourth quarter of the midterm election year to the second quarter of the following year, should help the S&P 500 finish 2026 up 8% to 12%, according to Stock Trader’s Almanac Editor-in-Chief Jeffrey Hirsch’s forecast. .SPX YTD Mountain S&P 500 Year-to-date, Hirsch’s forecast is for the S&P 500 index to be positive for the fourth consecutive year. The index is headed for its third consecutive year of positive growth, rising more than 17% in 2025. It also increased by 24.2% and 23.3% in 2023 and 2024, respectively. “I don’t think the (artificial intelligence) boom is going to end just because the year is new,” he said. “We will have a transition to a new Fed, but if it’s seamless and continues the current (easing) cycle, it could be positive, and I expect it to be.” Hirsch also believes that the market selloff that followed President Trump’s “reciprocal” tariff announcement in early April was “in some ways ahead of the typical midterm election year downturn,” not to mention that this year marks Trump’s second year as president. The editor-in-chief emphasized that the market performs much better during the interim period of a second term under the same president, and that is especially true for Republican presidents in their second term. Notably, in all intervening years dating back to 1949, the S&P 500 Index has risen an average of 4.6%. In the sixth year of a two-term president, the middle year of his second term, the composite index increased by an average of 12.4%. 2026 also happens to be the sixth year of this decade, and the S&P 500 index hasn’t fallen in this year since 1966, Hirsch said. “Next year will be even rougher,” he said in an interview. “There won’t be much of an upside. We’ll see a bit more consolidation and weakness. But 8% to 12% is still pretty good,” he added.
