Why History Suggests a Volatile 2026 for the S&P 500

History presents a clear, recurring headwind for the S&P 500 heading into the 2026 midterm elections. The pattern is robust: within the 12 to 18 months preceding the vote, the index typically experiences a large drawdown. As senior strategist Harry Colvin at Longview Economics notes, this is a "typical" occurrence, driven by investor aversion to the uncertainty that midterms create, particularly the potential for policy gridlock and slower growth. The evidence shows this isn't a minor correction. Of the 16 midterm elections since 1920 that fell outside of recession years, twelve were preceded by pullbacks of more than 10% in the S&P 500. In fact, seven of those were declines of 20% or greater.

The range of outcomes underscores the volatility risk. The smallest pre-election drawdown on record was 7.4%, while the largest reached a staggering 41.8%. This wide dispersion means the market could face a significant correction in the coming months, regardless of the specific political outcome. The pattern is so consistent that Colvin describes these pre-election wobbles as "usually a good buying opportunity," framing the period as a potential entry point for investors willing to stomach the turbulence.

The key structural insight is the asymmetry in timing. The volatility is concentrated in the build-up, while the aftermath tends to be strong. After the election, uncertainty resolves and markets re-focus on fundamentals. Colvin's analysis shows the S&P 500 was, on average, higher by 5.8% after 3 months; 10.5% after 6 months, and 14.8% after 12 months post-midterm. This sets up a clear investment narrative for 2026: the primary risk is a notable drawdown in the 10 months leading to November, followed by a potential rally once the political dust settles.

Structural Drivers vs. Valuation Reality

The path for the S&P 500 in 2026 hinges on a critical tension. On one side, a powerful set of fundamental drivers is in place. Goldman Sachs Research forecasts the index's fourth-straight year of gains, powered by a projected 12% increase in earnings per share. This growth is expected to be underpinned by healthy economic momentum, corporate re-leveraging, and a productivity boost from AI adoption. The current earnings season is already exceeding expectations, with 91% of S&P 500 companies reporting blended growth of 13.1% year-over-year, marking the longest streak of double-digit expansion since 2021.

On the other side, the market's valuation and structure are stretched to extremes. The S&P 500 trades at a forward P/E of 22x, matching the peak multiple of 2021 and approaching the record 24x seen in 2000. More alarmingly, the Buffett indicator-the ratio of total US stock market capitalization to GDP-stands at 220%, signaling a market priced for perfection and as expensive as it was at the height of the dotcom bubble. This concentration is unprecedented, with the Magnificent 7 alone accounting for roughly 35% of the index's total market cap, making the entire benchmark vulnerable to a narrative shift.

Historical context adds another layer of caution. After three consecutive years of double-digit gains, the average next-year return for the S&P 500 has been about 8%, but the median drawdown during those years has been around 14%. This pattern underscores that even strong bull markets are not linear. The current setup is a classic test of whether robust earnings growth can justify these lofty multiples, or if the market's extreme concentration and valuation will amplify the volatility inherent in the pre-midterm cycle. The structural drivers are present, but they must overcome a valuation reality that increases the magnitude of potential downside if expectations falter.

Catalysts and Scenarios: Navigating the 2026 Path

The market's trajectory in 2026 will be determined by the interplay of two powerful, opposing forces. The first is the historical pre-election volatility, a recurring pattern that sets the stage for turbulence. The second is the structural economic and earnings growth that could provide a floor for valuations. Investors must watch for specific catalysts and technical levels to gauge which narrative will dominate.

The primary near-term catalyst is the expected pre-election wobble. As senior strategist Harry Colvin notes, the S&P 500 typically experiences a large drawdown within the 12-18 months before election day. For 2026, this volatility is likely to unfold in the first half of the year. A significant pullback would test the thesis that these periods are "usually a good buying opportunity." The magnitude of that correction will be a key signal of how much investor uncertainty is priced in.

The fundamental check on high valuations will be the trajectory of corporate earnings and AI investment. Goldman Sachs Research forecasts a 12% increase in earnings per share for the S&P 500 in 2026, driven by healthy economic growth and a productivity boost from AI. This growth is already evident, with 91% of S&P 500 companies reporting blended earnings growth of 13.1% year-over-year in the latest quarter. The sustainability of this expansion, and the pace of AI spending that fuels it, will be the critical metric throughout the year. If earnings disappoint, the market's elevated forward P/E of 22x leaves little room for error.

Finally, a critical technical level will signal a broader breakdown. The market's extreme concentration makes it vulnerable to a narrative shift. The S&P 500's key support level near 7,500 points is a watchpoint. A decisive break below this level could indicate that the correction is no longer confined to the AI sector but has spread to the broader market, amplifying the historical midterm pattern. The competing forces are clear: the cyclical uncertainty of politics versus the structural momentum of earnings, with technical levels providing a real-time gauge of which is winning.