Investors are already expecting Democrats to regain control of at least one of the two houses of Congress. However, if their victory turns out to be more convincing than forecasts, US stocks could come under new pressure. UBS strategists warn of short-term sell-offs, while political analysts see a deeper question - what the election result will mean for US economic policy after 2028.
US stock markets enter the final days before the midterm elections for Congress in an unusual situation. The S&P 500 index has risen by about 12% since the beginning of the year, but in the past three weeks it has moved away from its record close on October 6. Investors are no longer worried so much about whether Democrats will achieve success, but how big it will be. The difference is significant because financial markets react not to political events themselves, but to the deviation between expectations and actual results.
According to the Kalshi and Polymarket prediction markets, the probability of Democrats winning the House of Representatives is about 90%, while their chances of regaining control of the Senate are estimated at approximately 65%. This means that the scenario of divided government in Washington is largely already included in stock market valuations. President Donald Trump will likely have to work with a Congress in which Republicans will not have the current freedom to push through their legislative initiatives.
The problem for Wall Street would arise if Democrats win a significantly larger majority than expected. Kurt Reiman, head of midterm election analysis at UBS, warns that a lead of more than a seat or two in the Senate, combined with a majority of a dozen or even twenty seats in the House of Representatives, could cause a short-term decline in stocks. The main reason is the risk that investors will start to expect stricter regulatory policies.
Such a reaction would be especially interesting given the strong performance of US stocks in recent years. Big technology companies, the financial sector and some industrial companies have benefited from expectations of a more favorable tax and regulatory environment. A convincing victory for the Democrats could call into question some of these expectations, even if the immediate possibilities for legislative changes remain limited.
But a big political victory does not automatically mean a big change in economic policy. And that may be the most important consideration for investors.
Even if Democrats control both chambers, the president retains his veto power. To override it, a two-thirds majority in the House and Senate is needed — an outcome that analysts say seems unlikely. A Democratic victory could therefore make it harder for new Republican initiatives to be passed, but it would not necessarily allow the opposition to impose its own agenda.
From an investment perspective, this creates a curious paradox. Markets can initially react negatively to a political outcome, but then find that actual legislative changes will be limited. Such a sequence would explain why UBS expects any weakness in stocks to be short-lived.
After the initial reaction, Ryman believes that attention will return to economic fundamentals — growth, the Federal Reserve's monetary policy, inflation, budget decisions and corporate earnings. This is a logical position. Political elections can change expectations about the future, but they do not, in and of themselves, immediately change Microsoft's revenues, American household consumption, or the investment budgets of large corporations.
The more interesting question is whether the elections will not mark the beginning of a deeper shift in the political attitudes of American society.
Nathan Dean, a senior analyst at Bloomberg Intelligence, draws attention to the possibility that a big victory for the Democrats could intensify the intra-party clash between the progressive wing and the centrists. According to him, such a debate could last for years and have implications for the presidential election in 2028.
This is a factor that Wall Street has difficulty estimating in advance. A more left-leaning economic agenda could include higher taxes on large corporations, tighter controls on technology companies, and changes to financial sector regulations. A centrist approach would suggest more moderate changes and greater continuity in economic policy. For now, however, these are possible policy directions, not specific legislative decisions.
Therefore, investors should distinguish between two different horizons. The first covers the immediate aftermath of the election, when unexpected results could trigger heightened volatility. The second extends to 2028, when political changes could affect taxes, government spending, and the regulatory environment.
Historically, Wall Street has often viewed divided government as a favorable scenario. The popular thesis is that when the president and Congress cannot easily reach an agreement, the risk of radical policy changes decreases. This creates predictability that investors generally value.
But UBS disputes the widespread belief that political gridlock is necessarily good for stocks. According to Ryman, historical evidence suggests that stock markets can perform well under divided governments, but it does not prove that political gridlock is the cause of positive returns.
This distinction is important. Under a single government, large-scale tax and economic reforms can be adopted that stimulate corporate investment and consumption. Under divided governments, such initiatives are often delayed or blocked. On the other hand, limiting legislative changes can reduce political uncertainty. The ultimate effect depends on the economic environment, not just on the distribution of seats in Congress.
There is another risk that deserves attention. Political gridlock can make it more difficult to negotiate a budget and increase the likelihood of conflicts over funding the federal government. If such disputes coincide with a slowdown in the economy or higher inflation, the market reaction may be longer than expected.
For now, UBS does not recommend changes in investment portfolios due to the upcoming elections. This is indicative. Analysts see the possibility of short-term fluctuations, but not enough grounds for a significant change in strategic asset allocation.
In my opinion, the most interesting scenario is a convincing victory of the Democrats, followed by an initial sell-off and a gradual recovery of the market. Such a development would be logical if investors first react to the political signal, and then realize that the possibilities for radical legislative changes are limited.
However, this does not mean that every correction after the elections will necessarily be a buying opportunity. If signs of weakening corporate profits, more sustained inflation, or a more restrictive Federal Reserve policy coincide with political uncertainty, the market may find enough fundamental reasons to continue its decline.
The election can be the trigger for the sell-off, without necessarily being the real cause of it.
Ultimately, the 2026 midterm elections will be an important test of the US stock market's ability to absorb political uncertainty. If the Democrats win, the biggest surprise would not be the change in control of Congress itself, but the scale of the political change.
And as Washington prepares for a new distribution of power, investors will likely continue to monitor far more prosaic indicators - inflation, interest rates, and corporate earnings.
Because politicians can change the mood on Wall Street in a matter of days. But the sustainable direction of the market will ultimately depend on whether the US economy continues to generate growth and profits.
Source: money.bg