Midterm Market Pullbacks: Nothing New, Still Uncomfortable
This is the part of investing that never gets any easier. The markets have been on a painful downward trajectory ever since late February when the conflict with Iran kicked off. While there is still hope things get figured out soon, many people have real concerns about the current situation. While the Iran conflict would have been difficult to predict, there is another phenomenon at play known as the “mid-term effect.” Historically mid-term election years(the 2nd year of a 4 year presidential cycle) tend to be some of the most volatile years for stocks.
On average, the S&P 500 experiences about an 18% downturn at some point during these years¹. Over time, mid-term elections have exacerbated existing recession fears, earnings dips or geopolitical concerns. So far this year, the market dips have been driven by concerns about employment with the rise of Artificial Intelligence, worries about companies overspending on AI tools and infrastructure and of course the oil price spikes that have accompanied the war in Iran. When you add the mid-term election to those concerns, its easy to see why markets have struggled a bit this year.
Even though we can expect market drops every once in a while, they are still not very much fun to live through. What I want to reinforce with this piece is what typically happens AFTER these downturns. Since 1950, the average 12 month return from a market bottom has been 32%². So while these dips are brutal while we are experiencing them, they can be followed by strong recoveries.
Why Midterm Years Tend to Be Difficult
1. Policy uncertainty
Markets tend to do worse in times of uncertainty. During midterm years, investors are trying to figure out who will control Congress and what that means for taxes, regulation, and spending going forward. This uncertainty leads investors to demand a “risk premium,” which pushes prices lower³.
2. Front-loaded policy changes
Historically, administrations often push through more controversial or restrictive policies earlier in their term—things like tax changes or increased regulation. That can slow economic momentum in the second year⁴.
3. Constant political noise
Midterm years tend to come with heavy headlines—policy fights, shutdown threats, and general political tension. Even if nothing fundamentally changes, the perception of instability can weigh on markets³.
Even Outside Midterm Years, volatility is normal
One important thing to remember is that even in “normal” years, the market isn’t smooth.
- The average intra-year decline for the S&P 500 is about 14%.⁵ So we can expect the market to go down double digits at some point in a typical year.
- Drops of 20% happen roughly once every three years⁵
- Long-term returns still average about 10% annually⁶
The last point is what matters most. The path tends to be bumpy, but the long-term direction has been positive.
What Happens After Pullbacks
One of the more overlooked facts about the market: forward returns tend to improve after declines.
Historically:
- After a 5% pullback → ~12% average return over the next 12 months⁷
- After a 20% pullback → ~31% average return over the next 12 months⁷
In other words, the worse it feels in the moment, the better things have typically been going forward. To be clear, I realize this doesn’t make it easier to live with, but its something to keep in mind if you are worried about a downturn.
Every Decline Feels Different (and Scary)
In speaking with people over the past month, I have often heard some version of “this time is different.” In fairness, its possible that this time really is different, but that is not the best investment strategy in my opinion. There’s always a reason to be nervous in real time as we have seen over the past handful of years. Here are just a few of the events we have seen recently:
- 2025: tariff concerns
- 2024: unwind of the yen carry trade after rate hikes in Japan⁸
- 2022: inflation, Fed rate hikes and the war in Ukraine⁹
- 2020: COVID-19 pandemic¹⁰
- 2011: debt ceiling crisis¹¹
Each situation feels unique (and often unprecedented) while it’s happening. That’s what can make it so difficult to stay invested.
A few practical takeaways:
- Yes, things could get worse. The market being down ~9% doesn’t mean it’s done falling.
- History shows us that things tend to recover. There are no guarantees in investing, but there is the potential for things to bounce back.
- Timing the bottom is nearly impossible. Markets tend to bottom on bad news, not good news. Paradoxically the best time to buy is when sentiment is the worst. The issue is that its hard to tell when sentiment is as bad as it will be and by the time things “look better,” a good portion of the recovery is usually already behind us³.
- Stick to the basics:
- Stay diversified
- Have a plan
- Avoid panic decisions
Final Thought
Be thoughtful about the financial information you consume. Bad news sells and there are always countless pundits who are looking for a soundbite when the markets are down. There are always more things that COULD go wrong then do and fear mongering can sound rational in a downturn. I’m not suggesting you bury your head in the sand, but it can drive you crazy to follow the news too closely. I would encourage you to stay calm and use history as your guide. If you ever have questions or need someone to talk things through with, feel free to give me a call.