RBC Capital Markets has reviewed how U.S. equities behaved during the second half of the two most recent midterm election years, 2018 and 2022, as investors consider the potential for renewed market volatility in the next election cycle.
Both periods were marked by significant swings, unlike the two latest presidential election years, when equities advanced. In 2018 and 2022, the S&P 500 reached a high in either August or September before falling to a low in October. The index then recovered to another peak in November before declining again in December.
Those fluctuations were substantial, although RBC strategist Lori Calvasina said the volatility ultimately contributed to the formation of more durable market lows that remained intact into the following year. Elections were only part of the picture, with Federal Reserve policy and interest rate concerns influencing both periods. Trade tensions added pressure in 2018, while a technology earnings downturn and the Russia-Ukraine war complicated the backdrop in 2022.
Sector performance also displayed similarities across the two midterm years. Consumer Staples and Health Care generally outperformed during the second-half sell-offs, while Technology and Consumer Discretionary were among the weaker areas. When markets subsequently rebounded, Financials, Industrials and Materials led, while Communication Services, Consumer Staples and Health Care lagged.
“To be clear, we are not calling for this kind of turbulence in the months ahead, but we did find the exercise useful for thinking through tail risks, particularly regarding the timing of inflections,” Calvasina wrote.
RBC’s latest factor analysis also indicates that high price momentum has recently returned to outperformance within both the S&P 500 and Russell 2000, while EPS quality has been weaker. Commentary from second-quarter earnings calls suggested companies continue to face a fluid operating environment, with geopolitical uncertainty, inflation, supply-chain pressures and limited housing turnover among the challenges being discussed. At the same time, businesses have highlighted opportunities linked to artificial intelligence, energy and reshoring.
The bank’s research also suggests equities have historically continued to advance while deal activity remains elevated, with difficulties typically appearing after transaction volumes begin to fade.
From a valuation perspective, Calvasina said forward price-to-earnings multiples for the S&P 500 and Nasdaq 100 currently sit around the middle of their respective post-COVID ranges. A similar picture is evident among the largest companies in the S&P 500, while the Russell 2000’s forward P/E is close to its average.
Looking over the next 12 months, the strategist continues to hold a constructive view on the S&P 500, although interest rates remain the most important threat to that outlook. In the absence of a greater recession risk or an interest rate shock, she expects market declines to remain within a 5% to 10% range. RBC currently gives Growth and U.S. equities a modest advantage over Value and markets outside the United States.