U.S. equities could face a more unsettled backdrop as the next midterm election cycle approaches, with RBC Capital Markets looking to 2018 and 2022 for clues about how markets have historically behaved during comparable periods.
The second halves of both midterm years were volatile, differing sharply from the upward moves recorded during the two most recent presidential election years. In both 2018 and 2022, the S&P 500 established an early-autumn peak in August or September, declined to an October low, recovered to another high in November and then fell to a further low in December.
RBC strategist Lori Calvasina noted that while those market swings were sizeable, they ultimately played a role in creating more sustainable lows that extended into the following year. Political uncertainty was not the only driver. Federal Reserve policy and interest rates were important considerations during both episodes, while trade policy created additional pressure in 2018. In 2022, investors were also dealing with weakening technology earnings and the Russia-Ukraine war.
There were notable similarities at the sector level. Consumer Staples and Health Care proved relatively resilient during the declines in both periods, while Technology and Consumer Discretionary underperformed. Leadership shifted during the subsequent recoveries, when Financials, Industrials and Materials performed strongly and Communication Services, Consumer Staples and Health Care trailed.
“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.
Separate factor analysis from RBC suggests high price momentum has recently regained strength across both the S&P 500 and Russell 2000, while EPS quality has fallen behind. Second-quarter corporate earnings calls also painted a mixed picture of the operating environment. Businesses highlighted challenges including geopolitical tensions, persistent inflation, supply-chain disruption and weak housing turnover, while reporting healthier conditions in areas exposed to AI, energy investment and reshoring.
Deal activity provides another potentially supportive indicator. RBC found that equities have generally continued moving higher while transaction counts remain strong, with market difficulties tending to emerge only after dealmaking activity loses momentum.
Valuations, meanwhile, do not appear to be at the extremes of their recent ranges. According to Calvasina, forward P/E ratios for both the S&P 500 and Nasdaq 100 are around the midpoint of their post-COVID ranges. The biggest S&P 500 companies show a similar valuation pattern, while the Russell 2000 is trading at approximately its average forward earnings multiple.
RBC remains constructive on the outlook for the S&P 500 over the coming year, with interest rates identified as the main threat to that stance. Calvasina expects corrections to be limited to roughly 5% to 10% unless recession concerns intensify or markets experience an interest rate shock. Within its broader positioning, RBC currently sees a slight advantage for Growth over Value and for U.S. equities over international markets.
