Wall Street expects Democrats to win control of at least one chamber of Congress in Tuesday's US midterm elections, setting the stage for potential sharp swings in both stock and bond markets, according to a report.
AI regulation, defense spending, and cryptocurrency legislation are all expected to be on the agenda.
A basket of Republican-linked stocks tracked by UBS has fallen sharply since peaking in August, significantly underperforming the S&P 500 Index.
One major area where the impact could show up is the AI trade that has driven the stock market over the past few years, as Democrats are expected to push for stricter regulation and oversight of the technology. At the same time, local governments are under pressure to block data center construction in their communities.
Robert Waldner, chief investment officer at Invesco Advisers, said that if the election's "major political signal" is that "data centers are bad, that will have an impact on growth."
Meanwhile, other industries could also be targeted. If Democrats push to curb defense spending, military contractors could come under pressure. Large banks that profited handsomely from the trading boom could face scrutiny. And cryptocurrency-related companies could draw congressional attention simply because the industry has close ties to the Trump family.
All of this is prompting some Wall Street professionals to position for stock selling pressure and rotate into safer government bonds. Additionally, many traders appear overly locked into existing positions and expectations of a split Congress, leaving them vulnerable to sharp volatility.
Karl Schamotta, a strategist at Corpay, said: "Investors are entering the election long the dollar, short duration, with little protection against volatility, especially in stocks. The consensus expectation is that a narrow Democratic victory will produce gridlock, allowing the president to advance his goals through executive action, but there are significant tail risks."
With just days to go before voting day, the following markets and stock sectors are worth watching.
US Treasury Bonds
History shows that congressional gridlock is good for bonds because it prevents aggressive policies that widen deficits and push up long-term Treasury yields. But this time, bond market observers say any fiscal relief will be limited and unlikely to produce a sustained rally, because the deficit is running at about 6% of the economy, a level rarely seen outside of recessions.
Oliver Chambers, head of fixed income SMA at Clark Capital Management, said: "We simply have too much debt, and one day we will have to face it. But if over the next two years gridlock means we don't keep adding debt at the pace we have been, I think that's a good thing."
If Democrats perform particularly strongly, investors may read it as a signal that the American public supports AI regulation, which would weigh on tech stocks and dampen economic growth expectations — in that case, Treasury yields could move lower.
The Dollar
Like Treasuries, the dollar could also get a boost from a Democratic win, for the same reason: the stabilizing effect of a divided Congress. Some investors believe a divided government could push US President Donald Trump to lean on policies he can advance unilaterally through executive power.
Any escalation with Iran that Trump has hinted could occur after the election is expected to continue supporting the dollar by pushing up energy prices and prompting the Federal Reserve to raise rates. New tariffs could also support the dollar by stoking inflation — unless they trigger the kind of global "sell America" trade that became popular last year.
Tech and AI Infrastructure
Regardless of the midterm outcome, Trump will remain president and could veto any legislation seen as harmful to the tech industry. That could limit the risk to Nvidia and big AI spenders such as Alphabet, Meta Platforms and Microsoft.
Still, strategists are preparing for a stronger-than-expected Democratic showing to hurt sentiment around the AI trade. Arianna Salvatore, head of US public policy research at Morgan Stanley, said: "The key to the midterms is not the risk of federal policy immediately restricting data centers, but rather laying the groundwork for legislation that could come as soon as 2029."
Morgan Stanley analysts said data center REITs and emerging cloud service companies are vulnerable to proposed compute taxes. On the other hand, off-grid power providers such as Bloom Energy, Cummins and GE Vernova could get a boost from stricter policies.
Healthcare
Tobin Marcus, head of US policy and politics at Wolfe Research, said hospitals could benefit if Democrats succeed in reversing the Medicaid cuts included in last year's tax bill. He said Democrats could seek wins in healthcare if they pursue concessions in possible debt ceiling negotiations.
Jefferies analysts said hospital stocks such as Acadia Healthcare, HCA Healthcare and Tenet Healthcare have near-term upside tied to the election. Insurers Centene and Oscar Health could also see buying on hopes that Democrats will negotiate to restore enhanced Affordable Care Act subsidies that expired at the end of last year, though the firm considers that outcome unlikely.
Defense
Defense contractor stocks have underperformed this year on concerns that a big Democratic win could lead to stricter oversight and funding delays. Drone stocks such as AeroVironment and Kratos Defense & Security Solutions have fallen the most. If Democrats control one or both chambers, funding critical to the Pentagon's ambitious drone production plans could be at risk.
However, JPMorgan believes military spending could rise if Republicans hold their ground, and named L3Harris, Lockheed Martin and Northrop Grumman as potential beneficiaries.
Financials and Cryptocurrency
JPMorgan believes Republicans favor lighter regulation of the financial industry, so an unexpected Republican landslide would benefit lenders such as Bank of America, Citigroup and Wells Fargo. But Barclays analyst Jason Goldberg said the election is unlikely to change issues such as bank stress tests, because the heads of the Federal Reserve, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency may remain in place for several more years.
In the cryptocurrency space, if Democrats control Congress, the odds of industry-friendly legislation could decline. Democrats and a handful of Republicans blocked the Clarity Act in September, sending stocks such as Coinbase and Circle Internet Group sharply lower.
Potential Investigation Targets
Wall Street is bracing for a wave of Democratic investigations. Evercore ISI said AI-focused hearings could create market risk, with companies such as Nvidia and Amazon already receiving Democratic inquiry letters. Evercore also expects Democrats to launch investigations into industries tied to affordability issues, including energy, healthcare, food production and agriculture.
Companies that received US government equity stakes, such as Intel, IBM and rare earth producer MP Materials, could also face inquiries, putting their share prices at risk.
The Musk Empire
A Democratic win of one or both chambers could affect Tesla and SpaceX, owned by Republican mega-donor Elon Musk, as investors anticipate a possible merger of the two companies. Vikram Rai of First New York said that while Congress alone cannot kill a deal, an empowered Democratic Party would be able to slow it down. He said: "If there is a blue wave, both stocks face significant headline risk."
Comments