US midterm elections are approaching: Wall Street bets on a divided Congress, will the market get a modest breather?
- Core view: Wall Street sees a "divided Congress" as the base-case scenario for the midterm elections, believing that the two parties controlling the Senate and House separately will force policy toward moderation, ease uncertainty, and allow the market to focus on economic fundamentals.
- Key elements:
- Investors expect Democrats to retake the House and Republicans to keep the Senate, with a divided setup reducing the likelihood of major policies being implemented quickly.
- Historical data shows that when a Republican president is in office and Congress is divided, US stocks have gained an average of 13.7% annually, far higher than during periods of one-party control.
- AI regulatory risk has become an election focus, and under a divided government, the probability of disruptive policy changes in AI, defense, and healthcare is greatly reduced.
- If the results deviate from expectations (such as a Democratic sweep), stocks could swing sharply; a Republican sweep would benefit the energy and financial sectors.
- Some institutions believe the election outcome has limited impact on long-term investment strategies and that short-term volatility should be seen as an opportunity to adjust portfolios.
Author: Li Jia
Source: Wallstreetcn
As the U.S. midterm elections enter their final stretch, Wall Street is increasingly treating a "divided Congress" as the base-case scenario, viewing such an outcome as a relatively moderate policy result under the current market environment.
According to Bloomberg, investors widely expect Democrats to retake the House in November while Republicans retain control of the Senate with a narrow margin. The market believes this configuration would reduce the likelihood of major policies being implemented quickly, forcing the two parties into gridlock or compromise on more issues, thereby easing policy uncertainty.
Stuart Kaiser, head of U.S. equity trading strategy at Citigroup, said in a note to clients that a "divided government" would "force both sides into gridlock or compromise," making policy choices more moderate and "allowing the stock market to focus on corporate and economic fundamentals."
Meanwhile, the market is also positioning early for volatility around the election. Futures markets linked to the Chicago Board Options Exchange Volatility Index (VIX) show that demand for downside protection on the S&P 500 in early November has risen noticeably.
A Divided Congress May Be the Market's "Optimal Outcome"
Historical data supports Wall Street's optimistic expectations. According to data compiled by Carson Investment Research, since 1950, when a Republican president is in office and Congress is split between the two parties, U.S. stocks have gained an average of 13.7% annually; by comparison, when Congress is controlled solely by Republicans or Democrats, average annual gains have been just 8.3% and 4.9%, respectively.
Brian Gardner, chief Washington policy strategist at Stifel, said: "Investors are anticipating a divided Congress. If that indeed turns out to be the case, with Democrats winning the House but not by an overwhelming margin, I think we could see a relief rally of some degree."
Artificial intelligence has also become one of the most closely watched issues in this midterm election cycle. As backlash over data center construction continues to build, investors are being forced to confront the rising regulatory risks facing the core technology that has driven the four-year bull market in U.S. stocks.
Under a divided government, the likelihood of disruptive policy changes in areas such as artificial intelligence, defense, and healthcare would be significantly reduced — which is precisely the core logic behind the market viewing this as the "most positive outcome."
A "One-Party Sweep" Could Trigger Violent Market Swings
However, the market's strong consensus on a divided Congress itself constitutes a potential risk — should the final result deviate significantly from expectations, stocks could face violent swings.
A Democratic sweep of both chambers is not out of the question. While Trump remains the Republican Party's biggest mobilization force, his record-low approval ratings are becoming a major drag on the party. Republicans are pinning their hopes on a midterm campaign rally informally dubbed "Trumpapalooza" to avoid repeating the crushing defeat during Trump's first term.
According to Bloomberg, a team led by Bank of America strategist Michael Hartnett noted last month that a strong Republican performance, with Texas Governor Greg Abbott winning re-election, would provide a clear boost to AI-related trades; conversely, if Democrats take the Senate and Abbott loses, stocks would face a "sharp selloff."
Phil Wool of Rayliant analyzed that a Republican sweep would benefit sectors poised to gain from further deregulation, with energy and financials as potential beneficiaries; while a Democratic "blue wave" could drive strength in renewable energy and healthcare service providers.
Institutions Positioning Early, Long-Term Strategy Still Prevails
Although the market is positioning ahead of the election results, not all institutions believe the midterms are enough to change long-term investment strategies.
Omar Aguilar, CEO of Schwab Asset Management, said that while political outcomes always make clients uneasy, most election results have limited actual impact on long-term market trends. He acknowledged that short-term volatility in specific sectors would increase, but believes this should be viewed as an opportunity to adjust portfolios rather than a signal to change overall strategy.
"Clients are paying attention, just like they pay attention to $100 oil," Aguilar said. "But does that mean they have to change their strategy? Our advice has always been: no, just stay the course."
