The cyclical trap investors cannot ignore in 2026: The midterm election year dilemma of the S&P 500

Wall Street’s Optimism May Be Missing Something

2026 looks full of opportunities, and Wall Street analysts are generally optimistic about the U.S. stock market outlook. However, Bank of America’s research indicates that this optimism may overlook a widely ignored pitfall—the second year of a U.S. presidential term (coinciding with midterm elections) has historically been unfavorable for risk assets. In other words, the expectations of a steady rise in 2026 may underestimate the severity of this cyclical challenge.

Historical Data Reveals the Midterm Election Year Effect

Since 1871, the S&P 500’s average gain in the second year of a presidential term has been only 3.26%, less than half of the 6.43% average gain in other years. The probability of closing higher also drops significantly, with a 58% chance of gains in midterm election years compared to 65% in typical years.

More notably, this disadvantage has not diminished over time. Since 1940, the average return in the second year has been 4.22%, compared to an 8.85% average gain in other years. Since 1970, this divergence has become even more pronounced: the average return in midterm election years is only 0.58%, versus 9.25% in other years. This indicates that the pitfall effect during midterm years is actually strengthening rather than fading.

Seasonal Fluctuations Within the Year: Weak Early, Strong Late Pattern

Bank of America’s Chief Technical Strategist Paul Ciana points out a clear seasonal pattern within midterm election years: January and June tend to be weaker, while March shows support. Specifically, since 1970, January has averaged a decline of -1.77% in midterm years, well below historical norms; June typically drops nearly -2%, also notably weak.

This pattern persisted into mid-year but reversed toward the end of the year.

Strong Rebound in Q4: The “Santa Claus Rally” Effect

The fourth quarter of midterm election years shows remarkable resilience. Since 1940, the S&P 500 has a high 86% probability of rising in Q4 during midterm years, with an average gain of 6.6%. This far exceeds the 3.9% average gain in Q4 of other years and the lower probability of gains.

October and November are particularly strong, with positive returns in over 70% of midterm election years, making them some of the highest months for monthly gains during the presidential cycle. This creates a unique trading pattern: early weakness followed by a strong finish.

The 2018 Exception: Not All Midterm Years Follow the Pattern

Not all midterm election years follow the historical script. In 2018, the S&P 500 (tracked via Vanguard S&P 500 ETF (NYSE: VOO)) rose mid-year but then plunged over 13% in Q4, ending the year down 6.2%. The anticipated year-end rebound failed to materialize, as market sentiment was dominated by Federal Reserve policy concerns and trade tensions.

How Should Investors Prepare for 2026

If history offers guidance, investors should brace for increased volatility and limited returns for most of 2026 until the end of the year. Notably, Bank of America’s research also finds that gold performs well during turbulent midterm election years. Since 1970, gold’s average gain in such years has been 15.1%, surpassing its long-term annual growth rate.

The first quarter of midterm election years has a positive return of up to 86%, followed by typical corrections from May to June, but then rebounding before year-end. For portfolios, this predictable cyclical pitfall requires proactive planning and strategy.