US midterms: Markets cheer Democratic win, betting divided Washington means fewer policy shocks

Markets have been volatile for weeks, speculating on the impact of the US midterm elections on the fiscal outlook. The Trump administration's sudden policy shifts, without opposition from a Republican-controlled Congress, caused global markets to experience turmoil, from tariffs to the Iran war. However, on Wednesday, as investors digested a historic Democratic victory in US midterm elections, markets rallied.

Investors assumed that the divided government in Washington would curb potential negative outcomes in areas like the Iran war, despite fresh concerns, such as the backlash against AI infrastructure buildout that has fueled economic growth and corporate profits. Mark Hackett, chief market strategist at Nationwide, stated that "gridlock is the market's friend."

Investors now view the election results as a green light to add risk to their portfolios. Global stocks surged, with all three major Wall Street indexes trading higher, and treasuries rose as investors anticipate divided government to limit government spending. The results could also influence foreign policy, with US Vice-President JD Vance distancing himself from President Donald Trump's decision to go to war with Iran, questioning its worth and blaming it for the Republican's electoral losses.

The market may start pricing in de-escalation, as indicated by Shawn Snyder, economic strategist at Potomac Fund Management. Market seasonality also favors investors, as the S&P 500 has returned 19.9% on average in the 12 months following midterm elections since 1946. However, the election outcome may have varying effects on different industries.

Managed-care organizations and hospitals may benefit from bipartisan support for extending ACA subsidies, while sectors counting on deregulation or policy tailwinds, such as financials, defence, and crypto, may face a less favorable backdrop. Despite concerns about AI sector growth being hamstrung by regulatory scrutiny, the immediate market reaction has not been as troubling as initially feared.

Some companies, like Amazon.com, Meta Platforms, and Alphabet, rose, while data center operators fell. Shares of chip stocks also declined, with the PHLX Semiconductor Sector Index sinking 3.6%. The market seems to be signaling a more rational trajectory of spending, which could be beneficial for economic growth. Democratic wins in five states with data center exposure might secure AI's politcal future, according to Jefferies strategists.

Democratic control of Congress is likely to lead to stronger oversight of fiscal policies and restraint on increased spending, potentially easing pressure on US bond yields.