The S&P 500 (^GSPC +1.18%) is widely regarded as the best benchmark for the U.S. stock market because it covers about 80% of domestic equities by market value. The index is currently 5% below its record high after falling in three straight weeks. Several factors have contributed to the drawdown:
- President Trump’s tariffs have coincided with weak gross domestic product (GDP) and jobs growth.
- Oil prices have skyrocketed to their highest levels in nearly four years.
- Midterm election years are fraught with policy uncertainty.
- The stock market is expensive by historical standards.
History says the S&P 500 could decline even further in the remaining months of the year as those situations continue to develop. Here’s what investors should know.
President Donald J. Trump delivers his State of the Union address. Image source: Official White House Photo.
President Trump’s tariffs have coincided with weakness in the U.S. economy
Trump has reshaped the global trade landscape by imposing sweeping tariffs on sector-specific goods and imports from most countries. “We are quickly building the greatest economy in the history of the world,” he wrote in January. But that statement runs contrary to the facts.
U.S. GDP increased 2.1% last year. Excluding the pandemic in 2020, that ranks as the slowest economic growth since 2016. Furthermore, U.S. employers added 181,000 jobs last year. Excluding the pandemic, that ranks as the slowest labor market growth since 2009. Neither figure paints the picture of a booming economy.
Soaring oil prices could become another economic headwind
The U.S.-Iran war has effectively closed the Strait of Hormuz, a waterway in the Persian Gulf that carries 20% of global oil and gas supply. The number of ship transits through the strait has fallen from about 150 a day to single digits since the war began, according to The Wall Street Journal.
Since late February, Brent crude oil prices (an international benchmark) have soared more than 40% to $103 per barrel, a level last seen in August 2022. U.S. consumers are already paying more at the pump. The average price for a gallon of regular gasoline recently topped $3.50 for the first time since the summer of 2024.
Midterm election years are normally volatile for the stock market
In the past, the S&P 500 has suffered a median peak-to-trough decline of 19% in midterm election years. Put differently, history says there is a 50-50 chance the index tumbles at least 19% at some point in 2026. That pattern can be attributed to policy uncertainty.
The political party in charge almost always loses a significant number of seats in Congress during midterm elections. That raises questions about whether the president’s fiscal, trade, and regulatory policies will lose steam. So, investors often take money out of stocks until that uncertainty dissipates.
Stock market volatility could be particularly pronounced as the 2026 midterms approach because Trump’s policies have proved especially polarizing. “With affordability a key issue in the U.S. midterms, supply chain pressures and energy prices are top of mind,” according to Morgan Stanley.
The stock market is expensive by historical standards
The S&P 500 currently has a forward price-to-earnings (PE) ratio of 20.9, a premium to the 10-year average of 18.9, according to FactSet Research. Baked into that valuation is Wall Street’s expectation that earnings growth will accelerate in 2026. In other words, investors have already discounted the fact that analysts expect strong earnings this year.
So what? Economic growth is the cornerstone of corporate earnings growth, so economic headwinds like tariffs and rising oil prices could cause earnings to increase more slowly than Wall Street expects. And a large downward revision to earnings forecasts could easily sink the S&P 500 because stocks are already expensive by historical standards.
However, the stock market is in a particularly precarious position today because midterm election years tend to be volatile anyway. That does not mean the S&P 500 will crash, but I think the odds of a severe drawdown are elevated. Investors should tread carefully in the current environment. Only buy high-conviction stocks whose earnings are likely to be materially higher five years from now, and only if those stocks trade at reasonable prices.
