Bank of America and Morgan Stanley have cautioned that the upcoming US midterm elections could significantly sway equity markets, with a Democratic sweep potentially weighing on stocks and AI infrastructure sentiment, while continued Republican control might bolster risk appetite and investment.
Michael Hartnett, Bank of America's chief equity strategist, noted that the rising probability of Democrats taking both chambers of Congress poses a "meaningful" threat to risk appetite. According to MarketWatch, if Democrats win control of the House and Senate, US stocks could fall by more than 10%.
The impact would extend beyond equities. Hartnett expects the US dollar and Treasury yields to decline, while international stocks could outperform as geopolitical tensions ease and foreign markets become less exposed to trade and military conflicts.
Prediction markets now place the odds of a Democratic sweep at 64%, up from under 50% a month earlier, with a 28% chance of Republicans losing the House but retaining the Senate, and a 9% probability of a Republican sweep, according to Polymarket.
Hartnett described a Democratic victory in both chambers as "an electoral shift from populist capitalism to populist socialism," anticipating higher taxes and increased regulation that could weigh on corporate earnings and investor sentiment. He argued that Democratic policies aimed at tackling inflation could challenge the K-shaped economic boom, where higher-income households have benefited disproportionately from stronger spending power and rising asset prices.
The policy shift could also pressure the artificial intelligence capital-expenditure boom, a key driver of US equity market performance. Hartnett emphasized that the potential loss of political capital for President Donald Trump could be more consequential than immediate tax and regulatory impacts, as a Democratic Congress would constrain Trump's ability to advance his agenda, including efforts to maintain US supremacy in AI relative to China.
Conversely, Hartnett outlined scenarios where Republican strength could support equities. If Republicans lose the House but retain the Senate, stocks could rise by more than 5%, creating a Goldilocks scenario of legislative gridlock that allows the AI capex boom to continue while preserving the dollar's exceptionalism. A Republican sweep would be the most bullish outcome, potentially driving gains of 10% or more and sustaining the AI trade, though prediction markets assign only a 9% probability to that outcome.
Morgan Stanley shares these concerns, particularly regarding AI infrastructure. Ariana Salvatore, head of public policy research at Morgan Stanley, said a Republican sweep would likely be the most constructive for AI infrastructure sentiment, as investors would expect fewer regulatory constraints and greater support for permitting reform, additional power generation, and development on federal land. A divided government would represent a status quo, preserving questions about the durability of the AI build-out, while a Democratic sweep would be the least constructive, potentially leading to tighter local restrictions and more federal scrutiny after 2028.
In the near term, Hartnett said investors may wait for Treasury yields to reach 6% before buying bonds more aggressively, but he is already "nibbling" at US 40-year bonds, alongside indirect yield-sensitive investments such as small-cap stocks and real estate investment trusts.
This article is for informational purposes only and does not constitute financial advice.
