Midterm Market Mayhem: Why History Matters, Even in a Record-High Earnings Season

The S&P 500 has reached record highs, thanks largely to second-quarter earnings season’s impressive performance. However, beneath this veneer of investor optimism lies a more nuanced reality. As we enter one of the most turbulent periods in the market calendar, it’s essential to revisit the lessons of history and consider their implications for investors.

Earnings growth has indeed broadened, with S&P 500 companies on pace to report at least a 50% year-over-year increase in earnings per share (EPS), according to FactSet. This is the highest growth rate since the second quarter of 2021. Furthermore, an impressive 86% of companies that have reported EPS have delivered above Wall Street estimates, outpacing both the five- and ten-year averages.

Historical data suggests that this period of midterm election years (August to October) can be particularly treacherous for investors. A review of past market performance reveals a pattern: in each of the years 1990, 1998, 2002, 2010, 2014, 2018, and 2022, the market experienced at least a 7% pullback during this time. The only exception was 2006, but it’s worth noting that the market dropped by nearly 9% from May to July.

Investors should exercise caution and consider hedging broad-based equity exposure as we enter a period historically marked by volatility. This isn’t a call to panic or sell all stocks outright; rather, it’s a reminder that corporate America’s exceptional financial performance doesn’t guarantee continued market stability.

The S&P 500’s reliance on second-quarter earnings growth is precarious at best, especially considering the extraordinary circumstances that have driven this performance. Investors often become complacent in the face of record highs, only to be caught off guard by a sharp downturn. In an era where corporate profits are being artificially inflated by tax cuts and other factors, it’s more crucial than ever to scrutinize market trends and identify potential pitfalls.

Examining historical patterns reveals that the current earnings season may be too good to last. The market’s euphoria is likely short-lived, but it also presents an opportunity for long-term investors to reassess their portfolios and consider strategic hedging. As we hurtle toward the most volatile period in the market calendar, one thing is clear: history may not repeat itself exactly, but its echoes are unmistakable.

Investors who stay vigilant and position themselves accordingly can better navigate this uncertain landscape. By scrutinizing market trends and identifying potential pitfalls, they can mitigate the risks associated with midterm election years and protect their portfolios from unforeseen fluctuations.