Apart from elections, what is the real core variable currently suppressing the U.S. stock market?

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There are still three months until the 2026 US midterm elections, and the market is increasingly pricing in political risk. However, according to Goldman Sachs’ latest research, the probability of the election itself triggering significant stock market volatility is limited. The real pressure on US stocks comes from the structural imbalance in volatility shaped by rapidly rising real interest rates and historically low stock correlations.

Goldman Sachs strategists Ben Snider and others pointed out in a report released on July 24 that option implied correlations have fallen to their lowest levels in decades, artificially suppressing index-level implied volatility. Meanwhile, the 10-year real yield has risen to its highest since 2023, and the 30-year real yield is close to the critical 3% threshold, a rare breakthrough in recent decades. The combination of these two forces increasingly strengthens the argument for going long index volatility.

Historical data show that during August to the election date in midterm election years, the median return of the S&P 500 index is 0%, with the market typically trading sideways; in the three months after the election, the median return rebounds to 6%. This pattern means that now is the window period for investors to buckle up and wait for uncertainty to subside.

Low correlations are suppressing index volatility; structural imbalance is historically rare

The most prominent technical characteristic of the current US stock market is the extremely low correlations between stocks. Goldman Sachs data show that the three-month option implied average correlation of S&P 500 constituents has fallen to its lowest level in decades, significantly suppressing index-level implied volatility, even as volatility at the individual stock and factor levels has increased sharply.

This divergence has created a historic abnormal gap: the difference between the S&P 500 index’s three-month implied volatility and the average implied volatility of individual stocks has expanded to rare levels. Goldman Sachs believes the continuing AI trading theme and the widespread use of covered call option strategies by market participants are important drivers behind the low correlation.

However, this structure is difficult to sustain. Goldman Sachs points out that as earnings season draws to a close and investors shift their focus to the midterm elections, inflation data, and macro issues such as geopolitics, the importance of macro drivers will gradually rise, stock correlations are expected to rebound, and index volatility may increase.

Rapid rise in interest rates poses a direct threat to equities, key thresholds are clear

The upward pressure on interest rates is another core risk variable currently. Over the past week, US Treasury yields have risen sharply, with the 10-year real yield at its highest since 2023 and the 30-year real yield approaching 3%, a level only briefly breached during the financial crisis in recent decades.

Goldman Sachs historical research shows that when interest rates move unidirectionally by more than two standard deviations within a specific period, the stock market is typically under pressure. With current market parameters, two standard deviations correspond to about a 50 basis point monthly increase in the 10-year nominal yield—meaning, if nominal yields rise to about 5% in the short term, or real yields rise to about 2.7%, US stocks will face significant headwinds.

Goldman Sachs maintains its interest rate path forecast: the 10-year US Treasury yield currently stands at 4.7%, expected to gradually drop to 4.3% over the next 12 months. However, the recent rapid rise in yields has made the rate environment much tighter for equities.

Historical pattern: stocks trend sideways before elections, funds return after

Looking back at data from 13 midterm election years since 1974, the median return of the S&P 500 index from early August to election day is 0%, significantly weaker than in non-election years for the same period; but in the three months after the election, the median return jumps to 6%, with markets typically recovering quickly after uncertainty subsides.

Fund flow data show the same rhythm. Goldman Sachs statistics indicate that around the past ten midterm elections, US mutual funds increased their cash as a percentage of AUM by an average of 0.4 percentage points in the three months before elections, and reduced it by 0.6 percentage points in the three months after; overseas investors on average reduced US stock holdings by 0.1% pre-election, and increased holdings by 0.5% post-election.

This “shrink first, expand later” flow pattern aligns closely with economic policy uncertainty and the seasonal pattern of stock market volatility. Goldman Sachs economists confirmed the robustness of this pattern even after removing factors such as unemployment from the economic cycle.

Election result’s direct impact on the stock market likely limited

Although the market’s attention to the midterms is rising, Goldman Sachs believes the election result itself is unlikely to be a major trigger for stock market volatility. Prediction market data show an 85% chance that Democrats will control the House, while the Senate results are nearly even. Split control of Congress (16% probability), Democratic sweep (43%), and Republican sweep (41%) are all possible outcomes.

Democrats are very likely to control the House, meaning the signaling value of the election outcome for future legislative direction is limited. Goldman Sachs also notes most of the current political uncertainty the market faces is not directly related to legislative policy itself.

However, investors are leveraging this midterm election to look for early indications ahead of the 2028 presidential campaign cycle. Inflation is the core issue in this round of elections. Voter concern with prices has further increased compared to early 2026. The probability of a Democratic sweep in prediction markets moves in tandem with gasoline prices. In addition, AI regulation is becoming a common concern of voters from both parties; Politico polling shows over 70% of respondents support some form of government regulation.

Stock market is largely desensitized to election odds, except for consumer sector

Goldman Sachs conducted systematic regression analysis on correlations between US stock sectors, factors, and theme baskets with prediction market odds. The conclusion: Over recent months, most equity assets have had virtually no substantive correlation with election outcome probabilities.

The only notable exception is the consumer discretionary sector, whose returns have recently shown a negative correlation with Republican victory odds, though the strength of this relationship is not significant. Goldman Sachs cautions that as election day approaches, this relationship may change, but so far there have been no cross-sector or cross-factor systematic election trading signals.

Year-to-date asset performance shows the energy sector leading with a 35% return, followed by industrials and information technology; consumer discretionary and communication services are down 8% and 4% respectively and under pressure. Goldman Sachs currently maintains overweight ratings on healthcare and materials sectors.

Risk warning and disclaimerThe market involves risks, and investors should exercise caution. This article does not constitute personal investment advice, nor does it take into account individual users’ unique investment goals, financial situations, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article apply to their specific circumstances. If you invest based on this, you bear all responsibility for the outcome. ```