Wall Street Bets on Divided Congress as US Midterms Near

Original author: Li Jia

Original source: Wallstreetcn

As the US midterm elections enter the final stretch, Wall Street is increasingly viewing a "divided Congress" as the baseline scenario, believing this outcome could be a relatively moderate policy result in the current market environment.

According to Bloomberg, investors generally expect Democrats to regain the House in November while Republicans keep the Senate, albeit with a narrow margin. The market believes this configuration will reduce the likelihood of major policies being enacted quickly, forcing both parties into gridlock or compromise on more issues, thereby easing policy uncertainty.

Stuart Kaiser, head of US equity trading strategy at Citigroup, said in a client note 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 bracing for volatility around the election. Futures tied to the CBOE Volatility Index (VIX) show that demand for volatility protection on the S&P 500 has risen noticeably for early November.

Divided Congress Could Be the Market's "Best Outcome"

Historical data supports Wall Street's optimism. Data compiled by Carson Investment Research shows that since 1950, when a Republican president has faced a split Congress, US stocks have gained an average of 13.7% annually; by comparison, when Congress is controlled entirely by Republicans or Democrats, the average annual gains are only 8.3% and 4.9%, respectively.

Brian Gardner, chief Washington policy strategist at Stifel, said: "Investors are expecting a divided Congress. If that's the outcome, with Democrats winning the House but not in a landslide, I think we could see a relief rally."

Artificial intelligence (AI) has also become one of the most closely watched issues in this midterm cycle. As backlash over data center construction continues to grow, investors are being forced to confront the rising regulatory risk facing the core technology that has driven the four-year bull market in US stocks.

Under a divided government, the likelihood of disruptive policy changes in areas like AI, defense, and healthcare drops significantly, which is the core logic behind the market viewing it as the "most positive outcome."

A Single-Party Sweep Could Trigger Sharp Market Swings

However, the market's strong consensus on a divided Congress itself poses a potential risk—if the final result deviates significantly from expectations, stocks could face sharp volatility.

A Democratic sweep of both chambers is not out of the question. While Trump remains the GOP's biggest mobilizing force, his record-low approval ratings are a major drag on the party. Republicans are pinning their hopes on a midterm campaign blitz informally dubbed "Trumpapalooza" to avoid a repeat of the losses during Trump's first term.

According to Bloomberg, a team led by Bank of America strategist Michael Hartnett noted last month that if Republicans perform strongly and Texas Governor Greg Abbott wins re-election, it would provide a clear boost to AI-related trades; conversely, if Democrats take the Senate and Governor Abbott loses, stocks would face a "sharp decline."

Phil Wool of Rayliant analyzed that a Republican sweep would benefit sectors poised to gain from further deregulation, with energy and financials as potential winners; a Democratic "blue wave" could boost renewable energy and healthcare providers.

Institutions Brace for Impact, Long-Term Strategy Still Prevails

Although the market is preparing for the election outcome in advance, not all institutions believe the midterms are enough to alter 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 certain sectors will rise, but believes this should be seen 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 is always: no, just stay the course."