In 2025, the S&P 500 (^GSPC 1.18%) rose 16% -- marking the third consecutive year the index posted double-digit gains. Thanks in large part to artificial intelligence (AI) stocks, Wall Street is calling for even further upside in 2026.
According to FactSet Research, the consensus target for the S&P 500 this year is 8,255 -- implying 21% growth over where the index closed at the end of December. While this forecast might tempt you to buy more stocks now, this year contains an extra variable that could possibly throw the bull market for a loop.
Let's dig into why 2026 may wind up being a unique year for the stock market and explore how smart investors are allocating capital right now.
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The midterm elections could influence the direction of the S&P 500 in 2026
In general, investors prefer steady, predictable outcomes. But, as with any election cycle, midterms carry a lot of uncertainty.
Despite cooling inflation, strong GDP growth supported by big tech's AI infrastructure efforts, and the potential for the Federal Reserve to cut interest rates, the outcome of the 2026 midterms is anyone's guess. That's not great for the stock market.
To drive home just how much uncertainty weighs on the capital markets, consider the following:
- There have been 17 midterm election cycles since 1957. During this time, the S&P 500 entered a correction -- experienced a decline of 10% or more -- on 12 occasions.
- Going back to 1950, the average drawdown -- peak-to-trough -- during midterm election years is 17.5%.
- Interestingly, midterm years witness the most pronounced intra-year pullback compared to other presidential cycles, such as pre-election years or the first year in office.
All this means heightened volatility is almost a guarantee this year. Moreover, investors should expect volatility to rise as the midterms draw closer in November.
How should you invest during a midterm election year?
One of the more common aspects of midterm elections is that the incumbent party often loses seats in the House of Representatives and the Senate. While a divided Congress might imply even further gridlock on Capitol Hill, historical data suggests this might actually be what investors need in order to break out of ongoing cycles of uncertainty.
According to Carson Group, the S&P 500 tends to rise 8.8% in a midterm year under a second-term president. Moreover, research from Capital Group suggests that the one-year average return after a midterm election is 15.4% -- roughly double the long-run average annual return of the S&P 500.
While near-term uncertainty will likely bring some turbulence to the stock market, sitting on the sidelines right now carries an opportunity cost that long-term investors shouldn't submit to. Given these details, I think there are a couple of prudent things smart investors can do right now.
First, I'd choose to build a healthy cash position. During periods of pronounced volatility, it's not wise to chase downward momentum in hopes that you're buying the dip. Often, you're actually getting caught up in a value trap.
Second, I'd trim exposure to any speculative positions in my portfolio and hold only my highest-conviction stocks. As a rule of thumb, these should be blue chip stocks with resilient business models that generate durable cash flow throughout various economic cycles.
