Will the US Stock Rally Lose Steam? History Shows the 'Most Dangerous Period' of Midterm Election Years Is Approaching

US stock markets are trading near historic highs, driven by strong corporate earnings and a broadening rally. However, BTIG strategist Jonathan Krinsky warns that investors may not want to be overly optimistic. Historically, US equities are approaching the most unstable period of midterm election years.

Increased risk of correction from mid-August to mid-October

Krinsky points out that market gains are no longer confined to a few large tech stocks, and overall sentiment is nearly perfect. Yet, he emphasizes that during midterm election years, the period from August 18 to October 11 is typically the most difficult trading window of the year.

BTIG's analysis shows that in 1990, 1998, 2002, 2010, 2014, 2018, and 2022, US stocks experienced at least a 7% pullback between August and October. In 1994, the maximum decline during the same period was about 5%, which widened to 8% by December of that year.

2006 was one of the few midterm election years without a clear decline from August to October, but the market had already fallen 9% from May to July, effectively pricing in seasonal selling pressure earlier.

Krinsky therefore believes the current moment is an appropriate time to reduce portfolio risk or implement hedging strategies for overall equity exposure.

Strong earnings support S&P 500 at elevated levels

Nonetheless, US stocks are also supported by solid fundamentals. The S&P 500 index remains near historic highs, primarily due to second-quarter earnings that significantly exceeded market expectations.

According to FactSet data, second-quarter earnings for S&P 500 companies are expected to grow at least 50% year-over-year, marking the largest increase since Q2 2021.

So far, about 86% of companies that have reported earnings have delivered earnings per share above Wall Street expectations, surpassing the five-year average of 78% and the ten-year average of 76%. If the final figure holds at 86%, it will be the highest rate of positive earnings surprises since 87% in Q2 2021.

Tug-of-war between seasonal risk and earnings momentum

Historical data indicates that US stocks are entering a seasonally vulnerable window, but the robust earnings growth demonstrated this quarter gives investors little reason to exit the market entirely.

As a result, the market may face a tug-of-war between two forces: seasonal selling pressure during midterm election years and strong financial performance from US corporations. Rather than a full-scale stock liquidation, reducing exposure or implementing moderate hedging may be a more suitable strategy under current conditions.