Investors should brace for fresh volatility as Americans head to the polls on Tuesday 3 November for the US midterm elections. With every seat in the House of Representatives and around a third of the Senate up for grabs, the results have huge implications for the world’s leading market.
Forecasters expect the Democrats to retake the House but the battle for the Senate is much tighter. If the Democrats secure the House but lose the Senate, managers agree that domestic policy will become more difficult to push through.
Colin Graham, head of multi-asset strategies at Robeco, said: “The scope for significant legislation appears limited and markets are generally comfortable with a degree of political gridlock if it reduces policy uncertainty.”
In such an environment, attention is instead likely to remain focused on executive actions rather than congressional legislation, he said.
Jim Caron, chief investment officer of portfolio solutions at Morgan Stanley Investment Management, added that a Democratic House and Republican Senate presents a “more balanced negotiation” on upcoming debt limit debates.
“Republicans and Democrats will need to compromise on fiscal spending plans and the ‘pay-fors’ that will likely come at the expense of corporate taxes and even some personal tax rates,” he said.
“This means that the pro-growth tailwinds generated by fiscal policy from [president Donald] Trump will slow at the margin but not entirely go away – this will get factored into future earnings in 2028 and beyond but will start to get priced more fully in 2027 because markets are forward-looking.”
While gridlock could force compromise of fiscal spending, Graham argued a Democrat victory in one or both chambers “could lead to a greater emphasis on healthcare and social spending during future budget negotiations”.
However, the picture changes if either party takes both the House and the Senate.
Caron argued that a strong Republican result would potentially be more positive for markets, as their policies have “generally been seen to provide more fiscal stimulus that favours pro-cyclical growth with bigger earnings upside potential,” he said. Meanwhile, Democrat policies “tend to favour more defensive sectors with lower earnings upside potential”.
In contrast, even if the Democrats secure both chambers, major legislation will still be tough to pass under a Republican president, given Trump’s ability to veto – and the Democrats would need a two-thirds majority in both houses of Congress to override this.
Paul Green, co-manager of CT Global Managed Portfolio Trust, said: “Major legislation would therefore be unlikely – a backdrop markets usually enjoy, particularly as any Democrat attempts to increase regulation, particularly in the AI space, would see pushback from the president.”
However, control of the Senate would give Democrats the ability to deny presidential nominations to roles including the courts and the Federal Reserve, he noted.
Sectors in the spotlight
The results will have a knock-on effect for US companies, with managers pointing to defence, technology and healthcare among the sectors most exposed.
For example, should the Democrats win both the House and Senate, David Coombs, manager of Rathbones’ multi-asset portfolio funds, expects more aggressive fiscal spending by the Republicans in the short-term – “a positive for defence spending”.
“It could involve a potential debt ceiling increase and additional Iran funding,” he added. “This is great for US defence stocks but not for fiscal deficit concerns, which are bad for equity valuations.”
But a more significant risk of a Democrat sweep would be the increased uncertainty around regulation and taxation, particularly for some of the market’s strongest performing sectors, such as technology.
Valentin Bissat, chief economist and senior strategist at Mirabaud Asset Management, said: “Technology and AI are among the most exposed, particularly given their importance to current US market leadership and the possibility of greater regulatory scrutiny.”
Graham also flagged technology as the most important sector to watch, arguing that the Trump administration has consistently supported investment in AI and the continuation of this will be a “powerful structural tailwind”.
Any disruption to this flow of support – such as through heightened regulatory oversight of the construction of data centres introduced by the Democrats – would likely have an impact on the progression of the AI infrastructure build-out.
Beyond the technology sector, Bissat added that energy, financials and healthcare could prove sensitive to changes in the political balance.
“From an asset allocation perspective, credit could be vulnerable if political uncertainty contributes to wider spreads, while sovereign bonds could benefit from a broader risk-off or growth slowdown,” he said.
The bigger picture
Looking beyond the midterms, managers broadly expect fundamentals, rather than politics, to drive markets. After all, there has been persistent volatility in the US prompted by policy uncertainty, yet the US equity market has continued to deliver strong results as economic growth and corporate earnings remain resilient.
Green said: “The past two years have shown that policy uncertainty and market volatility have decoupled and that, despite considerable political noise, markets have remained focused on fundamentals – strong earnings growth and a solid economic backdrop.”
If these two themes persist in the coming months, Green believes that higher levels of “political brinkmanship and drama out of Washington should not necessarily derail market momentum”.
Caron is also positive, maintaining a pro-risk portfolio as he thinks the underlying forces for economic growth remain intact. He is modestly overweight US equities and has a duration underweight in fixed income.
Bissat is also relatively constructive on the US in the coming months because US growth and corporate earnings remain resilient, but argued the risk environment has “deteriorated”.
“A benign election outcome combined with solid earnings could allow equities to move higher,” he said. “The downside scenario would combine political uncertainty with persistent energy-driven inflation, higher yields, wider credit spreads or disappointment around AI earnings.”
However, he has halved his high-yield exposure and increased sovereign bond duration and exposure to improve diversification “should growth slow or credit spreads widen”.
For Graham, the bigger question is what the results say about the balance of power in Washington in the longer term.
“If the Democrats fail to create the voting shift from the Republicans, then this gives us concerns about their ability to run a successful presidential cycle campaign in two years’ time – so this may prove more consequential for markets than the immediate policy implications,” he said.