You may not know it, but the 2006 stock market faces yet another major risk – midterm elections.

If you’re about to snicker and say that’s nuts, don’t. In the last four midterm elections, the S&P 500 – during periods in each of those years – sustained wicked losses: 19.9% in 2002, 8.9% in 1998, 19.3% in 1994, and 33.6% in 1990. All told, that’s an average decline in each of those years of about 10.4%.

I get these statistics from Larry Adam, the chief investment strategist of Deutsch Bank Alex Brown in Baltimore, Md., who ascribes much of these declines to political wrangling and mudslinging, which he thinks could intensify in the upcoming elections, given the great divisions in the country over the Iraq war. He also raises the possibility of political party changes in the House and Senate, which could create a great deal of market uncertainty.

Adding to the uncertainty, he points out, are geopolitical risks, namely a military confrontation with Iran over its nuclear ambitions and the prospects of a deadlier and more prolonged Iraq war.

That’s not all that concerns Mr. Adam, who, though recommending an overweighting in American securities, is becoming increasingly nervous. A key worry centers on interest rates. Like most market professionals, he sees just two more hikes in short-term rates, each of 25 basis points, which would push the fed funds rate to 5%. But if the Fed, as some contrarians are already predicting, should boost the rate to 5.25% or even 5.5%, Mr. Adam says that would raise the possibility of an economic hard landing or even a recession in 2007.

Usually, he points out, the market runs up before the end of a Fed tightening. “That’s what the market is anticipating, and that’s why we’ve had a rally”(about 6.6% over the past six months and 5.2% year-to-date). That rally largely assumes the Fed will stop at 5%, he says. And any indication to the contrary, he believes, given that the Fed is the market’s primary driver, would cause stock prices to slide.

The end of Fed tightening, assuming he’s right, invariably leads the market to focus on the account deficit, which ballooned in the fourth quarter to a record $224.9 billion, or 7% of GDP. Such a large deficit generally indicates impending dollar weakness (a matter of concern to many professionals and one of the events that precipitated the October 1987 market crash).

Another of his worries: For the first time in 12 quarters, earnings in the December quarter fell below Wall Street expectations. “I hope that was an anomaly and not a trend,” Mr. Adam says. He also notes that if the yield curve stays inverted (that’s when long-term rates are lower than short-term rates) – which is frequently a precursor of a recession – it often produces below-average stock returns.

Given his concerns, Mr. Adam figures “you could see a slightly down market for the rest of the year after the last Fed hike.” Accordingly, our worry-wart, who started off the new year by predicting the S&P 500 (which wrapped up 2005 at 1,248) would climb to 1,320-1,340 (it closed yesterday at 1,301.67), is prepared to raise more cash if his concerns become more pronounced. At present, his cash position is 5%.

Mr. Adam is quick to emphasize he’s by no means a raging bear, that significant market plusses are still out there. Among them:

* A strong economy.

* Double-digit earnings growth – on the order of 16% – is anticipated in the first quarter.

* Almost 10% of balance sheet assets are sitting in cash, which implies dividend increases, more mergers and acquisitions, and brisk capital spending.

* Overseas institutional portfolios are about 7% underweighted in American equities, and any reduction in that figure could be a solid market catalyst.

* The price of oil (now in the low $60s a barrel) should head lower, given a lot of supply coming to the forefront, and average between $55 and $60 for the remainder of the year.

However, in light of the market rally, Mr. Adam thinks it behooves investors to be especially selective. His favorite stock sectors – which also tend to be market leaders when the Fed stops tightening and during periods of yield curve inversion – are energy (primarily Halliburton and Cooper Cameron), materials (Barrick Gold), health care (Gilead Sciences, St. Jude Medical, and Amgen), and financials (AFLAC and St. Paul Travelers).

A concluding note of caution: The pluses sound good, but don’t ignore a big minus – the skidding periods of market declines during midterm elections.