U.S. stocks plunge amid midterm election turbulence! Wall Street's bullish expectations dashed, short-term selling pressure may be hard to ease

According to Zhitong Finance APP, for several weeks, major Wall Street trading institutions have been saying that after the U.S. midterm elections, the stock market rally will resume. The trading divisions of JPMorgan, Citadel Securities, and UBS Securities had previously stated that the midterm elections would act as a “removal of obstacles” event for the market, helping to ease pre-election market jitters. These trading desks believe that since a large amount of capital remains on the sidelines, investors are likely to rebuild equity positions.

The bullish view prior to the elections was mainly based on the judgment that investors had adopted overly defensive positioning before the election, so with the uncertainty resolved, they might increase risk exposure again. For example, according to data from Goldman Sachs’ Prime Brokerage, hedge funds reduced their equity risk exposure in October at the fastest pace since March.

Scott Rubner, head of equity and equity derivatives strategy at Citadel Securities, said this election could clear the way for a year-end stock market rally. He wrote in a client report on Wednesday: “As the dust of the election settles, market volatility may gradually return to normal, and investors will have significant room to reestablish risk exposure. With uncertainty fading and several major buyers returning to the market, we believe the U.S. stock market is most likely to continue higher toward year-end along the path of least resistance.”

Davide Montoni of UBS Securities expressed a similar view. He believes that, after a period of sharp volatility in tech stocks, this voting result could serve as a catalyst to push the market higher. He noted, “The earnings reports of hyperscale cloud service providers clearly failed to provide investors with the clear bullish signals they expected, but successfully navigating this election hurdle may be the catalyst that triggers a year-end short squeeze.”

JPMorgan’s trading division also expects tech stocks to rebound, and anticipates that the rally will spread from a few ultra-large-cap stocks to the broader market. The bank’s U.S. market intelligence team stated their tactical outlook remains bullish because the recent sell-off in tech stocks has created short-term rebound opportunities.

However, Thursday’s market performance dramatically reversed this view. Anxiety surrounding artificial intelligence (AI) trading resulted in a 4.4% plunge in the S&P 500 Index, the Nasdaq dropped more than 5% into technical correction territory, and the Nasdaq 100 saw $2.3 trillion wiped from its market cap. Currently, the market worries that with the Democrats gaining control in Congress and several states, they may tighten AI regulatory policies. Stricter AI oversight and local restrictions on data center construction may slow the pace of U.S. AI infrastructure investment.

John Flood, Head of Americas Equity Execution at Goldman Sachs, noted that Wednesday marked one of the busiest equity trading sessions for the bank this year. In a report to clients, he wrote that Thursday was “the exact opposite”—“our phones were ringing off the hook as clients asked for market updates and views. Unfortunately, we aren’t seeing much valuable information at the moment.”

He reported that long-only institutions were once again “frozen.” He pointed out that investors who aggressively cut equity exposure ahead of midterms were caught off guard by Wednesday’s rally. Hedge funds, meanwhile, began selling off shares of AI hyperscale cloud providers that they had just bought the day before.

Although a single trading day does not determine the trend, the previously bullish views of trading desks may still play out. Nevertheless, Thursday’s sell-off highlighted just how difficult it is—even for Wall Street professionals—to predict market direction.

It is worth noting that Alex Altmann, Head of Global Equity Tactical Strategy at Barclays, is one of the rare skeptics among major Wall Street trading desks. He had previously warned that the midterm elections were unlikely to be the clearing event that investors hoped for, as the most significant pressures holding back the market—such as whether AI investments can provide returns and the financing costs required for AI infrastructure—would not be resolved by the election outcome.

Systematic Capital Flows Further Intensify Selling Pressure

The magnitude of Thursday’s stock sell-off was also amplified by so-called “systematic strategies.” Many of these strategies trade by following the equity market’s direction, rather than being driven by fundamentals.

Barclays’ equity tactical strategy model shows that volatility control funds may reduce equity exposure by about 30 percentage points, marking one of the largest single-day adjustments since the market turbulence during the COVID-19 crisis. The model also indicated that, within the next 24 to 48 hours, these funds might sell about $135 billion in U.S. equity futures. Alex Altmann added: “As de-risking pressure spreads via real-money channels like retail and long-only investors, we expect this situation to persist tomorrow.”

ETF rebalancing operations further exacerbated market pressure. Barclays pointed out that Thursday was expected to be the largest ever leverage ETF sell-side rebalancing day on record.

Retail investors—previously a major source of demand during pullbacks—hesitated to step in. According to Vanda Research, retail investors on Thursday abandoned their signature buy-the-dip strategy and instead dumped individual stocks at the fastest pace since the peak panic days of the COVID-19 crash in March 2020.

Vanda Research noted that in the first 30 minutes after Thursday’s open, retail outflows marked the largest single half-hour selling event in recent months, nearly matching the peaks seen during the retail exodus in late July 2024. The firm added that, just before the close, net outflows from retail investors in individual stocks totaled $338 million. This round of selling was the third-largest retail single-day stock liquidation on record, only behind March 12 and March 17, 2020.

As retail investors retreated, institutional investors also broadly reduced risk, intensifying systematic sell-off pressure. Vanda analyst Viraj Patel noted that earlier this week, institutional demand for call options fell to its lowest point in a year. At the same time, leveraged ETFs faced forced rebalancing before the close, with expected size between $42 and $48 billion. Volatility-targeting funds are also simultaneously decreasing their risk exposures.

Viraj Patel warned that institutional buyers chose to exit just as retail investors and systematic strategies were aggressively liquidating stocks. Such a capital flow pattern is extremely rare and typically only occurs in times of extreme market stress.

UBS pointed out that retail-led selling triggered risk-control systems in the futures market as well as forced liquidations by leveraged ETFs. UBS further warned that systematic funds—particularly risk control funds—are expected to sell more than $100 billion worth on Friday, and that this round of correction may not have yet bottomed.

Charlie McElligott, cross-asset strategist at Nomura Securities, noted that current negative gamma positions in the market are “enormous,” meaning falling prices will continue to amplify the trend. Goldman Sachs’ CTA model estimates that if the market drops further, the S&P 500 could face about $164 billion in systematic sell pressure. BTIG Chief Technical Strategist Jonathan Krinsky reminded that rotation requires buyers on both sides. Healthcare is already 19% above its 200-day moving average—a record high—and defensive buying is losing steam. He therefore believes funding for the next round of defensive purchases is lacking.

Historical data also shows that the sell-off may intensify in the short term, although recovery often follows within three months. Frank Cappelleri, founder of CappThesis, reviewed previous U.S. midterm election cycles and found that historical experience suggests more near-term volatility. The chart analyst said that, since 1974, following 13 midterm election cycles, the Nasdaq rose 12 months after all but one. He remarked, “It should be noted that the process may be highly volatile.”

Using 2018 as an example, Frank Cappelleri noted that the day after the Democrats won House seats, the Nasdaq rose. Subsequently, there was a sharp sell-off in December, but a year after the election, the index was still about 15% higher.

Looking back at ten technical corrections in the past decade—after the sell-offs in 2025, 2022, 2020, and 2018—the Nasdaq experienced further sharp declines in the following month. However, in all cases except 2022, the Nasdaq resumed an uptrend six months later. The technical correction in January 2022 brought more negative results, with the Nasdaq dropping another 18.3% in the next six months and 24.3% after a year. On average, from the bottom of these technical corrections, the Nasdaq rose 9.41% in the following three months and 17.03% over the next six months.