U.S. corporate earnings for the second quarter have repeatedly delivered positive surprises, with profits far exceeding Wall Street expectations. However, the S&P 500 has been stuck in a rut since early May, with its rally largely stalling. New research from Deutsche Bank reveals a striking coincidence: looking back at all 20 midterm election cycles since World War II, the S&P 500 has generally shown weakness during the summer of the pre-election year. This historical pattern appears to be repeating, but the index has never recorded a negative return in the nine months following the election, suggesting the current lull might just be a precursor to a rebound.
Deutsche Bank strategist Jim Reid, after an in-depth study of all 20 U.S. midterm election cycles since WWII, found that the S&P 500 typically enters a period of sideways consolidation or even pullback in the year before the election, with volatility particularly pronounced around the summer months. About two months after the election outcome is settled, market confidence gradually recovers, and the index often resumes its upward trajectory. Most notably, in all 20 of these cycles, the S&P 500 has never posted a negative return in the nine months following the election—a perfect track record that remains intact.
A Stark Divergence Between Strong Earnings and a Stalled Index
The market’s current stagnation is not due to deteriorating corporate fundamentals. Deutsche Bank equity analysts note that roughly two weeks into the second-quarter earnings season, about one-third of S&P 500 constituents have reported results. Nearly 90% of these companies have beaten market profit expectations, with overall earnings surpassing consensus estimates by approximately 10%.
Deutsche Bank further estimates that overall S&P 500 corporate earnings growth for the second quarter could reach 34% year-over-year, significantly higher than the initial market forecast of 26%, indicating that corporate profitability remains quite robust. Yet, despite continuously improving fundamentals, the index has failed to reach new highs simultaneously, reflecting how the market is being constrained by political and external factors. This clear divergence between index-level stagnation and micro-level earnings improvement suggests that the market’s “inertia” requires explanation from other dimensions.
Iran Conflict Adds an Extra Layer of Uncertainty
Unlike previous midterm election cycles, the current situation is complicated by the additional variable of the Iran conflict. Analysts believe that the Middle East conflict is driving up international oil prices, which not only increases inflationary pressure but could also affect the approval rating of the incumbent U.S. party. As the election draws closer, future adjustments to the White House’s Iran policy will be increasingly influenced by political considerations, further elevating market uncertainty.
However, Deutsche Bank also notes that even excluding the Iran factor, the political uncertainty inherent in the midterm elections themselves is sufficient to prompt investors to adopt a wait-and-see attitude. The market’s current conservative sentiment reflects more of a systematic aversion by investors to policy direction and election outcomes, rather than a panic reaction to a single risk event.
Persistent Tech Giant Weakness Weighs on the Broader Market
From a market structure perspective, large-cap technology stocks remain a significant drag on the broader market. The group of mega-cap tech stocks known as the “Magnificent Seven” has largely been consolidating sideways since last September and has weakened further recently, limiting the S&P 500’s overall upside momentum. In contrast, other industry sectors have performed relatively steadily, with internal market rotation and divergence continuing to widen.
Analysts point out that the cooling of the AI investment boom is a key reason for the pressure on tech stocks. The market’s tolerance for hyperscale cloud service providers continuing to expand AI capital expenditure is gradually diminishing. Pressure on free cash flow, increased debt issuance, and a high-interest-rate environment are collectively constraining tech stock valuations. With large-cap tech stocks undergoing a continued correction, the midterm election effect intensifying, and geopolitical risks persisting, the market’s short-term defensive sentiment is unlikely to dissipate quickly.
Buffett Indicator Hits a New High, Valuation Risks Rise
Beyond political uncertainty and tech stock weakness, elevated market valuations are also drawing attention. Market signals indicate that the Buffett Indicator (the ratio of total stock market capitalization to GDP) has risen above 236%, reaching a new all-time high. While high valuations do not necessarily signal an imminent market reversal, amid a confluence of uncertainties including the AI boom, inflation, and interest rates, investors should remain mindful of the risks posed by stretched market valuations.
In summary, U.S. stocks currently face multiple challenges, including midterm election political uncertainty, escalating geopolitical risks, pressure from tech stock valuation corrections, and elevated overall market valuations. However, if the historical pattern established since World War II holds true once again, U.S. stocks could still be poised for a new wave of rebound after the election concludes. Deutsche Bank’s research provides a reference framework for the current market: if history repeats itself, the current downturn may be merely temporary, rather than the start of a structural shift.