Last week we reviewed how elections and whichever political party having control isn’t a specific make-or-break issue for markets over the long run. But they sure can test one’s patience in the short term.
Major indexes were up on Election Day while still dropping from 2% to nearly 5% last week. AI-related exposure was the x-factor again. Stocks directly and even indirectly related to AI had an especially rough day on Thursday, causing the S&P 500 to drop by over 4% and the tech-heavy NASDAQ to decline over 5.5%, or around $2.5 trillion worth of NASDAQ market value, according to the Wall Street Journal. Prices have recovered a bit since, which is typical following sharp selloffs.
The idea for the market’s course correction was mostly about how a “blue wave” hitting D.C. and state houses around the country could stall AI momentum, and how that could reverberate throughout the economy. That Democrats performed well last week wasn’t necessarily news, but their win margins were, especially in certain areas, and that caused an abrupt reset of expectations.
But this is exactly how markets are supposed work… investors collectively make assumptions, markets rapidly process new information that reinforces or challenges those assumptions, which leads to new assumptions (and new price expectations). The cycle is continuous and only changes speed based on levels of uncertainty. This can result in freak-out sessions before markets find their footing again. Markets can take a roundtrip through this process quickly, though, and sometimes even the pros are surprised by it.
Stretch out the view a bit, however, and the headlines become less important than economic and market fundamentals, and realistic expectations for how the politicians can impact it. For that I’m turning again to analysis from JPMorgan. If nothing else, the snippets below summarize what institutional investors are expecting from these political changes in the near term.
From JPMorgan…
The election will put significant restraints on the President for the rest of his term in office. Democrats control the floor in both chambers and can block his legislative agenda. The Senate also brings oversight and control of confirmations, and more Republicans may break with him where the party has traditionally differed.
Gridlock likely rules out new fiscal stimulus for two years. Democrats may push for household relief funded by higher taxes on the wealthy and corporations, but those measures would likely encounter a presidential veto. Government funding poses a more immediate challenge: temporary funding expires December 11, and the outgoing Senate still needs Democratic votes. A short extension into early 2027 looks most likely. Thereafter, continued funding of the Iran war seems unlikely with a Democrat-controlled House, creating shutdown risks in late 2027 or early 2028.
The debt limit has always involved extensive brinkmanship and will be key to watch. The Bipartisan Policy Center expects the ceiling to bind by midsummer 2027, with cash reserves and extraordinary measures pushing the real deadline to late 2027/early 2028. Most new Democratic senators are swing-state moderates, and with nobody wanting to own a default, a clean suspension remains likely, though not without fanfare.
We expect compromise to keep the government running, with no major tax changes. The $2.0 trillion FY26 deficit won't shrink much but shouldn't grow either. Democrats have little appetite for juicing the economy before the 2028 elections.
Affordability dominated the election, helping drive strong Democratic turnout. Democrats will prioritize restoring ACA subsidies and reversing Medicaid cuts, but most legislation needs 60 Senate votes to overcome a filibuster, and Trump could veto measures he opposes. We expect progress to be limited to narrower compromises, such as ACA credits in funding negotiations.
Data centers have become an easy political target amid rising electricity bills. Bipartisan energy permitting reform could help by accelerating new power generation and transmission, while politicians will aim to ensure developers pay for the incremental grid infrastructure required to serve them.
The elections reinforced growing opposition to data centers, particularly in Texas and Ohio, where incoming Democratic governors favor tougher development conditions. However, despite the backlash, statewide moratoriums have struggled to become law… AI remains an evolving public issue and is not yet a clear voter priority—Gallup found just 30% of voters considered data center construction extremely important to their vote.
We expect that the AI boom will remain on track, but may become costlier, slower and more consolidated in the coming years.
The effective tariff rate has fallen to about 10.6%, from roughly 30% after Liberation Day, and should continue to drift lower. Tariffs have become unpopular in both parties, giving Democrats an incentive to push for trade deals and lower rates. However, the President still wields considerable power on tariff policy and even a Blue Congress will be limited in its ability to lower tariffs on its own.
On Iran, further strikes are possible, but we expect the administration to seek a way out within weeks or months. Democrats can use Congressional control over spending and oversight to challenge the war, which is unpopular even with grassroots Republicans, while high fuel prices and public opposition are adding to pressure. Our base case is a compromise that helps bring oil prices lower in the coming months.
At the Fed, three of seven governors are Trump appointees. In June, the Supreme Court let Governor Lisa Cook stay while her case proceeds. The next two confirmations, Philip Jefferson's vice-chair term in September 2027 and Powell's board seat in January 2028, will now run through a Democratic Senate. That should limit further changes to the Board’s composition through 2028, reducing risk to Fed independence.
History favors stocks. As we noted in a recent blog, the S&P 500 has been higher 12 months after every midterm since 1950, averaging about a 15% gain.
For bonds, gridlock limits additional fiscal stimulus, while moderating growth and easing inflation (we expect inflation to peak by year-end and approach 2% by May 2027) should contain upward pressure on yields despite persistent deficits.
The political landscape has shifted meaningfully, but economic and market fundamentals should continue to matter more for markets than the balance of power in Washington.
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