With the U.S. midterm elections now just three months away, Goldman Sachs believes political developments are likely to become a more influential driver of market sentiment, potentially leading to higher volatility in the S&P 500 over the coming months.
Strategists led by Ben Snider said historical trends support the expectation that uncertainty surrounding economic policy typically increases as election season approaches.
Election Uncertainty Could Lift Market Volatility
“In past cycles, economic policy uncertainty has usually risen in the August ahead of midterm elections and remained elevated in the subsequent few months,” strategists led by Ben Snider said in a note.
According to Goldman Sachs, that historical pattern strengthens the argument for maintaining exposure to equity index volatility in the near term.
The bank noted that unusually low correlations between individual stocks have helped keep overall index volatility subdued, despite significantly higher volatility at both the stock and factor levels.
However, Goldman expects that dynamic to shift as corporate earnings season draws to a close.
While artificial intelligence-related trading and option overwriting strategies continue to suppress stock correlations, the bank believes “increased focus on macro issues including elections, geopolitics, and interest rate volatility” will contribute to higher index volatility.
Historical Performance Around Midterm Elections
Goldman Sachs also highlighted that the S&P 500 has historically delivered limited gains in the months leading up to U.S. midterm elections.
Across the 13 midterm election years since 1974, the index produced a median return of 0% between the beginning of August and Election Day.
The outlook has generally improved after the elections, however, with returns having “typically improved post-election,” producing a median gain of 6% during the following three months, according to the strategists.
Investor Flows Often Follow a Similar Pattern
The bank said investment flows have historically reflected the same cautious approach ahead of midterm elections.
Mutual funds and foreign investors have generally reduced their exposure to U.S. equities before Election Day before rebuilding positions once the election has passed.
Goldman Sachs believes growing attention to political developments, geopolitical risks and interest rate movements could become increasingly important drivers of market behavior as investors move closer to the November vote.