Midterm Elections and Markets: What Really Matters

Key takeaways 

• Elections matter, but history shows markets are driven more by fundamentals than political outcomes.
• Stocks have performed well across a wide range of partisan control scenarios, reinforcing the importance of staying focused on the bigger picture.
• Midterm years often bring volatility, but historically have been followed by stronger equity returns over the next 12 months.
• Today’s dominant market drivers remain inflation, interest rates, Federal Reserve policy, and earnings, alongside the powerful influence of AI and technology.
• Investors should be cautious about over-extrapolating election results into sector winners and losers.

Every election cycle, investors are tempted to adjust portfolios based on potential political outcomes. While elections can influence sentiment and policy at the margin, history suggests they are rarely the primary force shaping market direction.

Our long-standing view remains intact: elections matter, but other factors matter more.

Looking beyond Washington

Markets have delivered solid returns across a wide range of political environments. Whether power is divided or unified, the historical evidence shows that equities have been resilient, with differences in returns across political configurations far less pronounced than many might assume.

This underscores a critical point for investors: focusing too heavily on election outcomes can lead to misplaced conviction. Instead, the trajectory of the business cycle, monetary policy, and corporate fundamentals has consistently played a far larger role in determining market performance.

The midterm pattern: volatility first, clarity later

Midterm election years tend to follow a familiar script. Markets often experience heightened volatility, with larger intra-year drawdowns compared with other years in the presidential cycle.

However, that volatility has historically created opportunity.

In fact, stocks have risen in the 12 months following every midterm election in the modern era, supported by two primary factors: the removal of uncertainty and the tendency for policy to become more supportive as the next election cycle approaches.

Still, context matters. The magnitude of any post-midterm rally has varied depending on the broader economic and policy backdrop. In periods of restrictive monetary policy or slowing growth, gains have tended to be more measured.

Today’s backdrop: the real drivers of markets

While history provides a useful framework, today’s environment requires investors to focus on the forces currently shaping markets.

At the top of that list is monetary policy. The path of inflation and interest rates, and how the Federal Reserve responds, remains a key determinant of both economic growth and equity valuations. As we have seen in recent years, shifts in rate expectations can meaningfully influence market direction.

Closely tied to this is the trajectory of inflation, which continues to influence real incomes, corporate margins, and policy decisions. Even as inflation pressures evolve, its path will remain central to the market outlook.

Beyond macro policy, earnings growth is once again taking center stage. Markets ultimately follow earnings, and periods of sustained profit growth have historically supported equity gains regardless of the political backdrop.

The growing influence of AI and technology

A defining feature of the current cycle is the outsized role of technology and increasingly artificial intelligence in driving both earnings growth and market returns. This influence has pushed the information technology sector to nearly 40% of the S&P 500 Index, up from less than 25% at the start of midterm years prior to 2022.

Recent market leadership has been heavily concentrated in companies at the forefront of AI innovation, reflecting strong earnings momentum and long-term growth expectations. This dynamic reinforces another important lesson: structural trends often outweigh political ones.

Just as low interest rates and modest growth shaped market leadership in the past, today’s investment landscape is being reshaped by digital transformation and AI-driven productivity gains. These forces are global, persistent, and largely independent of election outcomes.

Avoiding common pitfalls: sector positioning and politics

One of the most common investor mistakes around elections is attempting to position portfolios based on expected sector winners and losers.

History suggests caution.

While conventional wisdom often links certain sectors to particular political outcomes, the data tells a different story. In recent cycles, sector leadership has frequently diverged from consensus expectations, driven instead by macroeconomic conditions and fundamental trends.

For example, sectors that were widely expected to lag following prior elections have at times gone on to outperform, highlighting the danger of relying too heavily on political narratives when making investment decisions.

The bigger picture: fundamentals drive markets

Stepping back, the key drivers of markets remain consistent:

• The direction of the economy and business cycle
• The path of inflation and interest rates
• Federal Reserve policy
• Corporate earnings trends

While elections may introduce uncertainty in the short term, they rarely alter these underlying forces in a meaningful way.

Bottom line

Midterm elections can influence markets at the margin, particularly in the near term as uncertainty rises and then recedes. But history is clear: they do not tend to meaningfully alter the primary trajectory of markets or the economy.

For investors, the more durable drivers remain in place: economic growth, policy, and earnings, alongside powerful structural forces such as AI and technological innovation.

While elections matter, other factors collectively tend to matter more. As a result, we strongly urge clients not to mix portfolios with politics.