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Market Perspectives: Making sense of the midterms

Anthony Willis
Senior Economist, Multi-Asset Solutions team

Key Takeaways

  • The Democrats will control both the House and the Senate from January 2027, but President Trump’s veto limits their ability to pass legislation, particularly on AI regulation.
  • Markets rallied after the results, in line with the historical pattern of divided government and a strong third year of the presidential term, before technology-led selling reflected regulatory concerns.
  • The Iran war and the resulting inflation cost Republicans votes, and the fall in the oil price suggests markets expect a stalemate rather than escalation.
  • Greater scrutiny of the AI build-out could improve capital discipline, while the scale of investment points to a multi-year theme that is far from over.
  • The US economy remains robust, and we view the recent pullback as market volatility rather than a deterioration in fundamentals.

The US midterm elections have delivered a clear outcome: the Democrats will take control of both the House and the Senate from January 2027. It will be the first time that Congress has been controlled by the Democrats during a Trump presidency, and the final two years of the current term are likely to look materially different from the first two.

What the Democrats will do with that power is far from clear, and that uncertainty probably contributed to last week’s market sell-off. They will have wide powers to scrutinise and subpoena the administration, and considerable scope for debate and brinkmanship over the budget and the debt ceiling. They will also be able to introduce legislation. At the same time, both parties will be positioning themselves for the 2028 presidential election; it remains two years away, but potential candidates are already being named on both sides.

Among the concerns is that the Democrats will seek to regulate the AI industry, which, interestingly, is something the industry has itself been asking for. Any such legislation can be vetoed by President Trump, who is strongly pro-AI. The Democrats are also supportive of the technology, although their backing is more nuanced. One of the notable features of the election was the number of states in which anti-AI sentiment helped Democratic governors make significant gains, in particular where they campaigned against the build-out of data centres in their territories. How the Democrats approach regulation therefore warrants close attention, but investors should bear in mind that President Trump holds the veto and has shown he is prepared to use it.

The war with Iran also featured. President Trump and Vice President JD Vance have both acknowledged that the conflict, and the inflation that has resulted from it, cost Republicans votes. US petrol prices are up 40% this year, and the market’s assumption, following those comments, is that the war will end sooner rather than later. Talks are ongoing, and views differ on how much progress is being made. However, the oil price suggests that markets have moved away from fears of escalation this side of the midterms and back towards a period of stalemate, with constrained flows through the Strait of Hormuz and continuing issues in other commodities and refined products. The oil price fell back significantly last week.

Historically, divided government has been positive for financial markets because little legislation gets passed, and the third year of a presidential term has typically been the strongest of the four. Consistent with that pattern, markets rallied significantly the day after the results, following the well-trodden path of relief once an outcome is known.

That rally was followed by a significant sell-off later in the week, led by technology stocks, with the rotation within US equities continuing while other sectors performed reasonably well. Hedge funds have been deleveraging through October and into November, and systematic strategies probably exacerbated the moves last week. In our view, the relief rally was undone by regulatory concerns: the prospect of wider AI regulation under the Democrats, and the pushback against data centres from governors in Democratic-controlled states.

Paradoxically, greater scrutiny could prove a blessing in disguise for some AI companies. There has been an arms race among them to build out data centres very quickly, which could create overcapacity. They are also likely to be overpaying, given the limited resources available for the build-out and the significant inflation in the raw materials these facilities require. That points to weaker capital allocation, at a time when these companies are borrowing substantial amounts to fund the investment.

Given the sums involved, there are also reasons to believe that the issues of concern to the Democrats, including public worries about access to water and electricity, can be mitigated over time. Moreover, plenty of states would be more than willing to see these data centres built within US territory.

It is important to keep the scale of the AI build-out in perspective. It dwarfs previous investment cycles, such as electrification and the construction of the railroads, telecoms and fibre networks, and it is a multi-year theme that is far from over. Markets, as they often do, have probably got ahead of themselves. We have seen some very strong earnings, alongside somewhat weaker guidance in certain cases, but the theme is likely to last for several more years, with capital expenditure remaining a major driver of both earnings and the wider economy.

That is a key point, as the US economy remains in very good shape. Friday’s nonfarm payrolls data were again very strong, and there is little in the data to suggest that the economy is slowing significantly. With expectations of Federal Reserve rate hikes next year having dimmed somewhat following last week’s fall in the oil price, the backdrop remains very supportive.

Markets do tend to blow off steam from time to time. We believe the underlying fundamentals remain solid, although there are nuances, and some countries are better placed than others. Ultimately, the AI theme still has time to run, and a market pullback should not be a major concern. We would be far more concerned if fundamentals were weaker, but they remain very robust.

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For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients).

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This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution.

For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

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Important information

For use by professional clients and/or equivalent investor types in your jurisdiction (not to be used with or passed on to retail clients).

This document is intended for informational purposes only and should not be considered representative of any particular investment. This should not be considered an offer or solicitation to buy or sell any securities or other financial instruments, or to provide investment advice or services. Investing involves risk including the risk of loss of principal. Your capital is at risk. Market risk may affect a single issuer, sector of the economy, industry or the market as a whole. The value of investments is not guaranteed, and therefore an investor may not get back the amount invested. International investing involves certain risks and volatility due to potential political, economic or currency fluctuations and different financial and accounting standards. The securities included herein are for illustrative purposes only, subject to change and should not be construed as a recommendation to buy or sell. Securities discussed may or may not prove profitable. The views expressed are as of the date given, may change as market or other conditions change and may differ from views expressed by other Columbia Threadneedle Investments (Columbia Threadneedle) associates or affiliates. Actual investments or investment decisions made by Columbia Threadneedle and its affiliates, whether for its own account or on behalf of clients, may not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not take into consideration individual investor circumstances. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Asset classes described may not be suitable for all investors. Past performance does not guarantee future results, and no forecast should be considered a guarantee either. Information and opinions provided by third parties have been obtained from sources believed to be reliable, but accuracy and completeness cannot be guaranteed. This document and its contents have not been reviewed by any regulatory authority.

In Australia: Issued by Threadneedle Investments Singapore (Pte.) Limited [“TIS”], ARBN 600 027 414. TIS is exempt from the requirement to hold an Australian financial services licence under the Corporations Act and relies on Class Order 03/1102 in marketing and providing financial services to Australian wholesale clients as defined in Section 761G of the Corporations Act 2001. TIS is regulated in Singapore (Registration number: 201101559W) by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289), which differ from Australian laws.

In Singapore: Issued by Threadneedle Investments Singapore (Pte.) Limited, 3 Killiney Road, #07-07, Winsland House 1, Singapore 239519, which is regulated in Singapore by the Monetary Authority of Singapore under the Securities and Futures Act (Chapter 289). Registration number: 201101559W. This advertisement has not been reviewed by the Monetary Authority of Singapore.

In Hong Kong: Issued by Threadneedle Portfolio Services Hong Kong Limited 天利投資管理香港有限公司. Unit 3004, Two Exchange Square, 8 Connaught Place, Hong Kong, which is licensed by the Securities and Futures Commission (“SFC”) to conduct Type 1 regulated activities (CE:AQA779). Registered in Hong Kong under the Companies Ordinance (Chapter 622), No. 1173058.

In Japan: Issued by Columbia Threadneedle Investments Japan Co., Ltd. Financial Instruments Business Operator, The Director-General of Kanto Local Finance Bureau (FIBO) No.3281, and a member of Japan Investment Advisers Association and Type II Financial Instruments Firms Association.

In UK: Issued by Threadneedle Asset Management Limited. Registered in England and Wales, Registered No. 573204, Cannon Place, 78 Cannon Street, London EC4N 6AG, United Kingdom. Authorised and regulated in the UK by the Financial Conduct Authority.

In the EEA: Issued by Threadneedle Management Luxembourg S.A. Registered with the Registre de Commerce et des Societes (Luxembourg), Registered No. B 110242, 44, rue de la Vallée, L-2661 Luxembourg, Grand Duchy of Luxembourg.

In Switzerland: Issued by Threadneedle Portfolio Services AG, Registered address: Claridenstrasse 41, 8002 Zurich, Switzerland.

This document is distributed by Columbia Threadneedle Investments (ME) Limited, which is regulated by the Dubai Financial Services Authority (DFSA). For Distributors: This document is intended to provide distributors’ with information about Group products and services and is not for further distribution.

For Institutional Clients: The information in this document is not intended as financial advice and is only intended for persons with appropriate investment knowledge and who meet the regulatory criteria to be classified as a Professional Client or Market Counterparties and no other Person should act upon it.

Columbia Threadneedle Investments is the global brand name of the Columbia and Threadneedle group of companies.

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