Goldman Sachs Warns of Rising S&P 500 Volatility Ahead of Midterm Elections

Investors should brace for a potential increase in S&P 500 volatility as the U.S. midterm elections draw closer, according to a new analysis from Goldman Sachs. Strategists at the investment bank noted that economic policy uncertainty has historically risen in the months leading up to the vote, a trend that could pressure markets in the near term.

Historical Precedent for Caution

In a note to clients, strategists led by Ben Snider highlighted that past election cycles show a distinct pattern for U.S. equities. This historical precedent, they argue, strengthens the case for holding equity index volatility hedges.

• The S&P 500 has generated a median return of 0% from the start of August through Election Day across 13 midterm cycles since 1974.
• Performance has typically improved post-election, with the index posting a median gain of 6% in the three months that follow.

This pattern is also reflected in investor behavior, with the report noting that mutual funds and foreign investors have historically reduced their U.S. equity exposure ahead of the elections before adding it back afterward.

Market Dynamics and Macro Risks

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Goldman Sachs observed that while volatility for individual stocks has been high, overall index-level volatility has been suppressed by record-low correlations between S&P 500 components. They attribute this low correlation to the ongoing AI trade and certain options strategies.

However, the strategists expect this dynamic to shift. As the corporate earnings season concludes, they anticipate that investor focus will pivot to macroeconomic issues, including the elections, geopolitics, and interest rate movements. This shift is likely to push index volatility higher. Adding to the pressure, the report noted that equities historically struggle when interest rates rise sharply, defining that threshold today as a one-month move of roughly 50 basis points in 10-year Treasury yields.

Political Outlook

While the political outcome remains uncertain, prediction markets currently indicate an 85% probability that Democrats will retake the House of Representatives, with control of the Senate seen as a toss-up. According to Goldman Sachs, this scenario reduces the likelihood of a major legislative surprise.

So far, few market sectors have shown a consistent relationship with shifting election odds. The strategists pointed out that inflation remains the dominant issue for voters, with prediction-market odds for a Democratic sweep moving in tandem with gasoline prices in recent months.