*Recorded and written before the November 3rd Midterm elections.
The S&P 500 Information Technology sector has officially entered a correction, with the index falling roughly 11% from its October 6 high. Rising concerns about the level of debt issuance amid an elevated cost of capital1 caused investors to take some chips off the tech table and move them into more defensive sectors, with Consumer Staples and Health Care the clear winners over the past month.
Figure 1. S&P 500 and Sector Performance Since October 6th High (%)
Sources: Standard & Poor’s, Bloomberg L.P., and Potomac. Past performance is not indicative of future results. Indexes are unmanaged and cannot be invested in directly. Historical performance is provided for illustrative purposes only and should not be considered a forecast of future results.
Given the correction's close connection to the artificial intelligence (AI) trade, it is not surprising that the worst-performing subsector during the past month was semiconductor equipment, with a 28.9% loss, though it remains up an impressive 39.9% year-to-date.
What Do Corrections Tell Us?
In some cases, corrections are a canary in the coal mine, warning investors of further downside. In other cases, they present a buying opportunity. But how does an investor know which is which?
One of the most important considerations is whether the economy is headed toward a recession. Our analysis of S&P 500 Information Technology sector corrections since 1991 found that when a recession was not imminent, the sector experienced an average additional decline of 6.9% over the following six months after the initial 10% correction. For corrections occurring during a recession or within six months before one began, that additional decline more than doubled to 16.0%.
However, investors should distinguish between how far stocks decline during a correction and how they ultimately perform over the following year. A market can experience substantial volatility, including a meaningful drawdown, and still finish the year considerably higher.
In fact, our historical analysis found that the S&P 500 Information Technology sector generated an average return of 27.3% over the twelve months following a tech correction, while the broader S&P 500 gained an average of 14.3% when a recession was avoided.
Figure 2. Historical Market Performance After a Technology Drawdown
Sources: Standard & Poor’s, Bloomberg L.P., and Potomac. Based on 40 completed twelve-month observations. Maximum total declines measure the deepest point reached relative to each index's 52-week high at the correction signal, including the initial decline. Forward returns measure performance from the next trading day's close through the following twelve months. Returns exclude dividends.
The takeaway is simple. Corrections can be painful even when the economy remains healthy, but they tend to be substantially worse when accompanied by a recession. That suggests investors should spend less time trying to identify the precise bottom in technology stocks and more time evaluating the underlying economic environment.
Right now, few investors or policymakers would likely argue that the economy is flashing recession signs with the Federal Reserve recently upgrading the status of the economy from solid to strong in their latest FOMC commentary. We don’t disagree, with real GDP having just clocked in at 3.4% in the third quarter of 2026.
Elections and the Removal of Uncertainty
Of course, technology is not the only thing on investors' minds. The midterm elections introduce another potential source of market volatility with investors weighing the implications for government spending, technology-related regulatory scrutiny, and the legislative agenda. More debt ceiling debates seem almost certain with Democrats set to take control of Congress and local debates about AI data centers will continue.
While midterm elections clearly matter, history suggests investors often place too much emphasis on which political party controls Congress.
Yes, political headlines will get louder with the change in Congressional leadership, but corporate earnings remain robust. Currently, consensus estimates are calling for an additional 20.5% and 16.9% in S&P earnings-per-share (EPS) growth in 2027 and 2028, respectively. Ultimately, that story faltering would likely prove much more determinantal to financial markets than who controls Congress.
Investing regularly comes down to climbing the wall of worry and focusing on data over feelings. In that vein, it may help to remember that the average one-year return for the S&P 500 following midterm elections since 1950 has been an impressive 18.8%.
That type of return seems optimistic to us given how far stocks have already run, but there has never been a negative return one year after a midterm election since 1950. The weakest return in over 75 years was still a positive 4.5%, which occurred during Ronald Reagan’s second term and included the 22.6% one-day decline in the Dow Jones Industrial Average on Black Monday.
Figure 3. S&P 500 Return One-Year After U.S. Mid-term Elections Since 1950
Sources: Standard and Poor’s and Potomac. Data as of November 2023. Past performance is no guarantee of future results. It is not possible to invest directly in an index.
We have no doubt that markets will be buffeted by a number of headwinds in the year ahead including the likelihood of more Fed rate hikes, more political brinkmanship, the ongoing Iran conflict, and the potential normalization or slowing of the pace of the AI buildout. Each of those events could lead to a pullback or even a correction, but stocks respond to profits. At the end of the day, just like Potomac believes in data over feelings, the stock market follows profits over feelings and those appear to be largely intact.
