Are US Stocks Entering the Midterm Election Curse? Deutsche Bank: S&P 500 May Dip Before Rebounding

US corporate earnings continue to outperform expectations, yet the S&P 500 index has remained nearly flat since early May. According to the latest research from Deutsche Bank, the market may already be pricing in political uncertainty surrounding the upcoming US midterm elections. Historical data shows that the S&P 500 typically underperforms in the year leading up to midterms, with a higher likelihood of pullbacks during the summer months. However, once elections conclude, markets have historically resumed their upward trajectory.

Jim Reid, a strategist at Deutsche Bank, reviewed 20 midterm election cycles since World War II and found that the S&P 500 has never delivered negative returns in the nine months following an election—a striking historical pattern. Statistically, markets tend to enter a consolidation or pullback phase about a year before the election, particularly evident around the summer. Roughly two months after election results are confirmed, market momentum typically resumes and sustains an upward trend.

The current stagnation in the S&P 500 is not due to deteriorating corporate fundamentals. About two weeks into the Q2 earnings season, roughly one-third of the index’s components have reported results, with nearly 90% exceeding earnings expectations. Overall profits are running about 10% above consensus estimates.

Deutsche Bank’s equity analysts project that the S&P 500’s Q2 earnings growth could reach 34% year-on-year—significantly higher than the initial 26% forecast—highlighting continued corporate strength. Yet, despite improving earnings, the index has failed to reach new highs, indicating that other factors are constraining market performance.

Beyond the midterm election effect, the current market faces additional uncertainty from the Iran conflict. The conflict has driven up global oil prices, increasing inflationary pressure and potentially affecting the incumbent party’s approval ratings. As the election draws nearer, White House policy adjustments toward Iran are likely to become more politically influenced, further heightening market uncertainty.

Deutsche Bank notes that even without the Iran factor, the political uncertainty from the midterms alone is sufficient to prompt investor caution. The current market’s conservative sentiment reflects uncertainty about policy direction and election outcomes, rather than panic over a single event.

From a structural perspective, large-cap tech stocks remain a key drag on the broader market. The so-called 'Magnificent Seven'—major tech giants—have largely traded sideways since September last year and have recently weakened further, limiting the S&P 500’s upside. In contrast, other sectors have shown relative resilience, with ongoing sector rotation and increasing market divergence.

Analysts point to cooling enthusiasm in the AI investment boom as a key reason for tech stock pressure. Investor tolerance for massive AI-related capital expenditures by major cloud providers is waning, as strained free cash flows, rising debt issuance, and a high-interest-rate environment collectively cap tech valuations. With large tech stocks correcting, midterm election effects intensifying, and geopolitical risks persisting, short-term defensive sentiment is unlikely to dissipate quickly. However, if historical patterns hold, US equities could see a fresh rebound following the election.