What could the US midterm election results mean for markets?

Despite some predictions of a close outcome in the US midterm elections, the Democrats won a clean sweep of both the House of Representatives and the Senate. President Trump’s willingness to accept the results in the face of the overwhelming result helped to remove a layer of political uncertainty and this was one of the factors behind the subsequent market rally.

Oil prices also fell as markets interpreted the Republican losses as a potential catalyst for pressure to bring the Iran war to an end.

Gold jumped 2.7% to $4,038 per ounce, which suggests that investors have added a little protection to their portfolio as a ‘just in case’ precaution. The precious metal may also be responding to incipient fears that the Democrats may go on a spending spree if they get the chance.

Specific issues such as Medicaid, defence, energy, AI, crypto and banking (de)regulation are all likely to be in focus and the race to the White House in November 2028 is now well and truly on.

Both parties will again be readying themselves and voters for the 2028 election as best they can, and that could mean government efforts to prime the economy – though whether there is capacity to spend freely to do so is open to question given the scale of US borrowings.

What does history tell us?

History suggests that the US equity market performs best, on average, in the third year of a presidential term, with an average double-digit percentage gain, against single-digit average percentage gains from years one, two and four, and only one ‘down’ third year since the Second World War.

Politics alone is unlikely to shape the fortunes of the S&P 500 and America’s other leading equity indices, as the backdrop to the best (and worst) returns from the third year of a presidency suggests.

The surge in year three of Bill Clinton’s first term came after the Greenspan interest rate shock and mid-cycle growth pause of 1994, while 1975’s bonanza under Gerald Ford, Nixon’s successor, followed the bear-market collapse of 1973-74 and the first oil price shock.

The S&P 500 bounced back in 2019 from 2018’s interest rate hikes and a down year for equities, to put a sheen on the first Trump presidency, from a stock market point of view, and the third year of presidencies from the Bush dynasty benefited from similar circumstances. In 1991, America was emerging from recession and in 2003 under George W. Bush, the US was casting aside the wreckage of the technology bubble bust of 2000-2002.

On the downside, US stocks fell for the only time during a third year of a presidency under Barack Obama in 2015.

Global growth worries, after the bursting of a bubble in Chinese equities, Greece’s debt default and what proved to be a temporary halt in quantitative easing in the US combined to hold back the S&P 500 and buck history at the same time.

Investors will therefore have to keep a close eye on events in Washington, but an even closer one on inflation, interest rates and corporate earnings growth, as well as valuation, which remains the ultimate arbiter of investment return.

Democrat victory could lead to greater regulation of big tech

Theoretically, a divided government can create gridlock for policy changes, but there is a school of thought that Democrats may prioritise pushing through AI regulation.

Equity markets are likely to pay particular attention to how the Democrats intend to regulate the AI industry.

Given the dominance of US AI companies both in their domestic and global equity markets, it poses some interesting questions about portfolio positioning.

AI has been the key to considerable stock market wealth creation in recent years, so the prospect of red tape could put the brakes on this hot investment theme.

Gradual legislation around AI could prevent rushed policy down the line that has a more dramatic market effect.

What about Meta’s bond and equity issuance?

What could be more telling for the sector than the midterms is the recent sour set of results from Intel and Meta’s new bond and equity issuances.

Meta made its first foray into the European bond market, issuing a $15 billion five-part bond offering, and followed up with a euro priced bond sale on 4 November. Last week, the company increased its equity offerings to $97.5 billion.

The increased demand to fund AI capex through both equity and bond issuance could be a key area to watch for market fatigue, potentially leading to investors seeking exposure to other more defensive parts of the market.