Barclays: Volatility may rise before the midterm election, but the year after the election is more supportive of U.S. equities, especially tech

Overview

This report starts from the U.S. midterm election cycle, analyzing historical performance of the S&P 500, style factors, and sectors in the 12 months before and after the election, and attributes key explanatory variables to changes in economic policy uncertainty (EPU). The report argues that midterm-related headwinds in equities generally peak in late summer, while in the 12 months after the election, risk assets usually improve in performance amid falling policy uncertainty and a relatively high probability of divided government.

Core views

Key views include: first, that U.S. market underperformance in midterm election years is not evenly distributed across the year, but is most pronounced in August and September; second, that the S&P 500 usually records above-average returns in the 12 months after the election, with Tech, Growth, and Quality performing most consistently; third, that Growth's post-election excess returns are largely driven by the tech effect, while Quality's improvement is more independent; fourth, that a fall in policy uncertainty, especially declines in national security and trade policy uncertainty, is an important mechanism behind stronger post-election Tech performance; fifth, the current base case is divided government, helping reduce legislative risk and support equity risk appetite.

Analysis framework

The report uses historical election-cycle comparisons, excess return statistics by style and sector, mean-difference tests of macro variables, analysis of the relationship between EPU changes and equity returns, and single-variable regressions to identify patterns and possible transmission channels of market performance before and after midterm elections. The sample mainly covers midterm election cycles from 1990 to 2025, with parts of the EPU analysis covering 1986 to 2025.

Methodology notes

• Historical cycle analysismidterm election cycle comparison

  Return comparison before and after midterm elections

  Compares the S&P 500 return path in midterm election years with non-midterm years, and further examines excess returns of styles, regions, and sectors in the 12 months after the election.

• Policy uncertainty analysiseconomic policy uncertainty

  Falling EPU and improved equity returns

  The report argues that policy uncertainty is usually lowest in the third year of a presidential term, and that S&P 500 returns over the next 12 months are strongest when EPU declines quickly.

• Statistical testingdifference of means and analysis of variance

  Macroeconomic cycle exclusion tests

  The report tests mean differences in growth, inflation, nominal rates, real consumption, and financial conditions across four-year election cycles, and argues that these macro variables do not adequately explain the main equity-return patterns.

• Regression analysissingle-variable regressions with HAC standard errors

  EPU components and tech excess returns

  The report uses rolling 12-month regressions of Tech sector excess returns on year-over-year log changes in EPU components, with 11-lag HAC standard errors to control for serial correlation.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• S&P 500

  US broad market equity benchmark, influenced by the midterm cycle and policy uncertainty

  Strengths

  Risk appetite typically improves in the 12 months after the election and third-year performance tends to be better; earnings revisions have improved more than index performance.

  Weaknesses

  In August to September before the election, it may suffer relative underperformance due to higher uncertainty and rising risk premia.

  Comparison

  Compared with non-midterm years, the first three quarters before a midterm tend to be weaker; the year after the election generally sees a recovery.

  Risks

  Position liquidations, leverage ETPs amplifying volatility, and a re-escalation of policy uncertainty.

• Tech

  The report's most favored sector direction

  Strengths

  Historically almost consistently leads in the 12 months after midterms, benefiting from lower EPU, AI capex, and improved global revenue visibility.

  Weaknesses

  Sensitive to trade, national security, and global policy environments; rising rates could pressure long-duration valuations.

  Comparison

  Average excess return over the last 12 months after midterms since 1990 is +14.5%, the strongest among sectors.

  Risks

  Critical Q3 2026 earnings indicators such as AI capex or memory pricing missing expectations, or policy uncertainty not declining as expected.

• Growth

  Post-election style beneficiary, but largely driven by Tech

  Strengths

  Historically stable excess returns in the 12 months after the election; upside in earnings remains a key support.

  Weaknesses

  The report argues that much of Growth's third-year performance is tech-driven rather than broad growth-style independent momentum.

  Comparison

  Compared with Value, the report prefers Growth, while acknowledging higher rate sensitivity risk.

  Risks

  Rising rates, tech drawdowns, or insufficient spillover of earnings revisions.

• Quality

  Post-election style beneficiary, co-moving with Tech rotation

  Strengths

  Stable performance in the 12 months after the election, and excess returns not fully explained by Tech alone.

  Weaknesses

  Lower pre-election consistency across styles.

  Comparison

  Unlike Growth, Quality's third-year effect remains relatively visible after controlling for Tech.

  Risks

  If risk appetite shifts sharply to high-beta or low-quality names, relative Quality performance may weaken.

• Healthcare

  A sector with relatively better pre-election performance

  Strengths

  Historically high hit rate of outperformance versus the S&P 500 in midterm election years.

  Weaknesses

  Not as stable as Tech over the 12 months after the election, with an average excess return that is negative in the table.

  Comparison

  Stronger than Industrials before midterms, but weaker than Tech after the election.

  Risks

  Policy, drug pricing, and regulatory uncertainty can affect valuation.

Key data

• September midterm election-year relative underperformanceabout 900 bpsThe YTD return gap between midterm years and non-midterm years for the U.S. market widens through summer and is most pronounced in September.
• Average Tech excess return over S&P 500 in the 12 months after midterms+14.5%In 8 of 9 midterm election cycles from 1990 to 2025, Tech beat the S&P 500 over the 12 months after the election.
• Average Growth excess return in the 12 months after midterms+460 bpsGrowth outperformed in all midterm election cycles since 1990 in the 12 months after the election.
• Average Quality excess return in the 12 months after midterms+410 bpsOutperformance occurred in all but one cycle, and is not fully identical to the Tech effect.
• Healthcare average excess return in midterm election years+7.7%Healthcare beat the S&P 500 in midterm years, with a hit rate of 7/9.
• Industrials average excess return in midterm election years-2.3%Industrials lagged relative to the S&P 500 in midterm years, with a negative pattern hit rate of 7/9.
• Probability Republicans retain House16%The election outlook cited by the report shows relatively low odds of Republicans retaining House control.
• S&P 500 valuationabout 20x NTM EPSThe report says valuation is below the 2/3/5-year average multiple after earnings revisions have outpaced index performance.

Impact & implications

The investment implication is that in the months before the election, adjustments may occur due to policy uncertainty, crowded positioning, and volatility-amplification mechanisms, but if fundamentals and earnings revisions remain supportive, pullbacks are more likely to offer a buying window in the second half of 2026. By sector, the report is more constructive on Tech, as it benefits from AI capital expenditure, global revenue exposure, and improved valuation visibility from lower national security and trade policy uncertainty.

Risks

• The historical sample contains only 9 midterm cycles, so small-sample bias is possible.
• AI capex, memory prices, and the 3Q26 earnings season may dominate market narrative more than the midterm cycle.
• If policy uncertainty does not decline or election outcomes diverge from the divided-government base case, post-election risk appetite improvement may be weaker than historical patterns.
• Crowded positioning, systematic flows, and the scale of leveraged ETPs may amplify short-term volatility.
• A high-rate environment may compress valuations of long-duration names such as Growth and Tech.

What to watch

• Relative S&P 500 performance versus pre-election risk-premium changes in August and September.
• Changes in control of the U.S. House and Senate, especially whether a divided government forms.
• The total EPU index and component EPU in trade, national security, tax, and monetary policy.
• AI capex, memory prices, and EPS revisions at large-cap tech companies during the 3Q26 earnings season.
• U.S. equity fund inflows, systematic positioning, equity sentiment metrics, and leveraged ETP AUM.