Strategists at RBC Capital Markets are flagging an increased likelihood of a pullback in U.S. equities of up to 10%, as the country heads into midterm elections and enters a historically soft stretch on the seasonal calendar. The team led by Lori Calvasina highlights that the S&P 500 has posted losses in September during five of the past ten years. They also note that the midterm election cycle could inject more volatility into the AI trade, given that artificial intelligence has become a subject of campaign debate, while the war in Iran remains an additional headwind.

"The risk of a primary, more common correction of 5% to 10% has risen for several reasons," Calvasina said. She added that worries over inflation and interest rates are now outweighing the recent boost in consumer confidence. According to data, the S&P 500 has climbed roughly 100% since late 2022, making it the second-strongest four-year performance ahead of a midterm election in history. In recent weeks, resilient earnings expectations have continued to underpin the market, even as inflation concerns build, WTI crude has jumped above $90 per barrel, and investors brace for a possible rate hike from the Federal Reserve next week.

While the S&P 500's recent rally has stalled, the index remains within 2% of its record high. The Calvasina team points out that, since the global financial crisis, pullbacks in the benchmark have typically stayed within a 5% to 10% range "unless there is a serious worry about a recession or an interest-rate shock." Still, the group holds a positive longer-term outlook and reaffirms its 12-month price target for the S&P 500 at 8,150 points. Based on Tuesday's closing level, that implies an upside of roughly 6%.