What the Midterm Elections Will Mean for Markets

Key Takeaways

• Affordability and policy surrounding AI data centers are top issues for voters this year.
• Financial and industrial stocks could come under pressure if Democrats win both chambers of Congress, while consumer staples and alternative energy stocks could benefit, according to analysts.
• Strategists emphasize that investors should not try to tailor their portfolios to the election outcome.

The United States midterm elections are less than a month away. Market-moving issues are front and center for voters, from data centers to inflation, the war in Iran, housing affordability, and more. Most of all, the election sets the scene for significant friction in Washington, where the likely winners of at least one chamber of Congress have campaigned heavily on slowing the main driver of stock market growth for the past three years: the buildout of artificial intelligence data centers.

For much of this summer, polls suggested the likelihood of a split Congress, wherein Republicans retain control of the Senate while Democrats gain control of the House. More recently, the odds have risen of a Democratic victory in the Senate. Some analysts see echoes of 2006: a second-term Republican president, an unpopular war in the Middle East, and rising gas prices. That year, the balance in Congress swung sharply toward Democrats.

Conventional wisdom says markets prefer divided governments, since political gridlock means neither party can pass expansive legislation. Analysts say that phenomenon may hold even with a Democratic sweep, since President Donald Trump has used executive power more broadly than his predecessors when it comes to trade, immigration, and foreign policy.

“I can’t envision a scenario for the composition of Congress after the elections that really changes the broader market or economic trajectory, and I say that because we’re going to have divided government regardless,” says Christopher Hodge, chief US economist at Natixis.

Against that backdrop, Dan Clifton, who leads the Washington policy team at Baird Strategas, pointed out this summer that sector- and industry-level dynamics could come to the fore.

Strategists warn investors not to let election headlines and outcomes drive portfolio decisions: “Historically, in the aftermath of a midterm, stocks tend to do well … Staying the course is often the best result," says Michael Arone, chief investment strategist at State Street Investment Management.

Sectors to Watch as Elections Unfold

State Street’s Arone says sectors highly levered to election outcomes, like industrials and financials, could come under pressure if Democrats take control of both chambers of Congress. Industrial stock performance is linked to the AI buildout and defense spending, while financial names are especially sensitive to regulation.

At the same time, Arone says consumer staples could benefit, thanks to Democrats’ focus on affordability and the possibility that they would try to eliminate Trump’s tariffs. Alternative energy stocks could also get a boost under Democratic leadership, along with some healthcare stocks if they can walk back some of Trump’s healthcare spending cuts.

Natixis’ Hodge says reinstating healthcare subsidies would also aid economic growth.

On the other hand, if Republicans maintain control of Congress, the landscape could look different. In a report this week, Clifton of Strategas said banks, industrials, defense stocks, managed care stocks, and data center real estate stocks could rally in that scenario.

Data Centers in the Spotlight for Voters and Markets

One of the most salient issues in this year’s elections is data center buildout amid the AI boom. The question is not cut-and-dry for either markets or politicians. AI technology is driving growth and regularly sending stocks soaring to new highs, and the data center buildout is driving up electric bills and straining power grids.

Hodge of Natixis says a populist backlash against data centers will define the political landscape down the road. “If there’s federal legislation floated for some sort of curtailment about AI or data centers … that could have a pretty noticeable impact on markets,” he says.

Analysts expect the greatest imminent impact on data center policy to occur at the local level, in state and governor races. At the national level, the infrastructure buildout shows no signs of slowing. “Both Republicans and Democrats recognize the importance [of being a leader in AI] for both economic and national security,” says State Street’s Arone. He expects capital spending on AI to continue, though he notes that Democrats may enact more structured oversight over the industry should they win both the House and Senate.

Rising Yields, Oil Prices, and Affordability Concerns

Also top of mind for voters this year is affordability—rising gas prices, mortgage rates, and inflation. The logic (and the concern among Republican candidates) is that “higher oil prices are leading to higher bond yields, higher inflation expectations, a lower approval rating for Trump, and higher odds of a Democratic sweep,” Strategas’ Clifton explained in a research note this week.

Regardless of which party controls Congress, ending the war with Iran could be critical to help ease the pressure on interest rates and bring gas prices back down.

Hodge of Natixis says a Democratic sweep could have major implications for bond yields, since Democrats are more prone to bigger spending. Further uncertainty around that spending “could be grounds for another bond selloff,” he says.

In general, analysts expect bond yields to remain elevated for some time regardless of the election outcome.

Constructing Election-Resilient Portfolios

So how should investors move forward? Philip Straehl, chief investment officer, Americas, for Morningstar Wealth, cautions against gearing portfolios toward any one election outcome. “Rather than positioning for a single result,” he wrote, “we think the better approach is to prepare for all plausible outcomes and make sure the portfolio has the appropriate offsets built in.”

For example, an overweight position in small caps could get a boost if Republicans maintain control of both chambers of Congress, thanks to the potential for more deregulation and legislation friendly to small business. That position could face headwinds if Democrats sweep both chambers, since the regulatory environment is likely to be less friendly for businesses.

On the other hand, an overweight position in US Treasuries versus corporate credit could face headwinds if Republicans take both chambers and reopen tax cuts. A divided government would be a tailwind for this position, since gridlock could reduce interest rate volatility. You can read more about those portfolio implications here.

“No plausible outcome is a headwind for the whole portfolio—each one is a tailwind for at least one of our positions,” Straehl explains. “Not every position responds the same way to a given outcome, and that is by design.”

That diversified, outcome-agnostic strategy can help investors weather volatility, too. Election years often bring bigger swings in the stock market. That said, State Street’s Arone says this year’s market hasn’t been quite as volatile as those in previous decades’ midterm election years. He says markets also tend to rise in the 12 months after elections, and that “Investors who can withstand the volatility and stick to their portfolio strategy have been rewarded.”