Signals to Watch in the U.S. Midterms

With Election Day a week away, our Head of U.S. Public Policy Research Ariana Salvatore and Wealth Management's Monica Guerra explain why the aftermath of the midterms may matter more to markets than who wins.

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Ariana Salvatore: Welcome to Thoughts on the Market. I'm Ariana Salvatore, Head of U.S. Public Policy Research at Morgan Stanley.

Monica Guerra: And I'm Monica Guerra, Head of Policy and Geopolitical Strategy for Morgan Stanley Wealth Management.

Ariana Salvatore: Today we're going to be talking about the upcoming midterm elections and what investors should be watching from both an institutional and individual investor perspective.

It's Wednesday, October 28th, at 10am in New York.

Well, Election Day is just about a week away. Investors are obviously increasingly focused on what a potential change in congressional control could mean for markets. And Monica, you and I are kind of grappling with this question through slightly different lenses. And that's why I thought it'd make sense to bring you in today.

We both agree that what happens after the election is probably more important than the outcome itself. But let's start with the election backdrop. Your team has developed a Midterm Signal Monitor. What are the indicators telling us?

Monica Guerra: Well, Ariana, affordability has really emerged as the defining issue for voters this cycle. Our monitor tracks four indicators positively correlated with midterm election outcomes: the generic congressional ballot, presidential approval, consumer sentiment, and gasoline prices.

Democrats lead the generic ballot by about eight points, and presidential approval is 38.8 percent, just below the 40 percent historical reference point when the opposition political party tends to gain momentum.

Now, consumer sentiment in October is the lowest of any October before a midterm election in the University of Michigan survey's entire history. And gasoline prices in September were up 37.6 percent from a year ago.

So taken together, these signals point to a challenging environment for the incumbent party, really driven by affordability. Persistent inflation, elevated borrowing costs, and renewed energy price pressures tied to the conflict with Iran are all weighing on household purchasing power. But importantly, these are directional indicators, not necessarily a forecast of the election outcome itself.

Now, Ariana, when you're looking at the potential outcomes from your perspective, how much do you actually expect to change?

Ariana Salvatore: Well, I think that's the key question, right? Because our view has been that the midterms are unlikely to fundamentally change the direction of U.S. policy. And that's because a lot of the uncertainty that markets have dealt with since the beginning of 2025 has come from the executive branch rather than Congress.

So, regardless of the outcome, we think things like tariffs, deregulation, immigration, geopolitics, export controls – all of those variables will remain important sources of policy uncertainty. Where congressional control matters more is on fiscal policy.

So, a divided government would make new legislation harder to pass, and that could mean more contentious negotiations over things like government funding, the debt limit, and defense spending.

So, for institutional investors, it's a little bit less about which party wins and more about what the composition of Congress means for the policy agenda going forward. As well as leadership's ability to really organize and corral different members of the caucus to effectively use their leverage around some of these negotiations.

So, Monica, I imagine the questions that you're getting from individual investors may be a little bit different. Talk us through some of those.

Monica Guerra: Yeah, they are. I think the biggest question is what the election can mean for an individual's portfolio. And history does offer us some interesting perspective here.

So, the S&P 500 has averaged about a 14 percent return in the calendar year following a midterm election, compared with roughly just 3 percent in the midterm year itself. And this year, as we all know, the index has already outperformed that typical second-year trajectory, which could heighten risks and opportunities for sectors sensitive to policy decisions.

For example, recent strength in technology and energy combined with the narrow market breadth could amplify policy-related volatility, particularly in industries facing heightened scrutiny under the new Congress.

Of course, that's not a forecast, and we caution against making portfolio decisions based on historical election patterns or political headlines alone; as the business cycle, corporate earnings, inflation, interest rates, and the AI investment cycle are likely to matter much, much more over the long run.

But one area where I do think our perspectives really intersect is the growing focus on electricity costs and data centers.

Ariana Salvatore: That's right, and it's actually one of the policy themes that we've been highlighting the most into the election. Our view is that the AI infrastructure build-out is unlikely to face broad federal prohibition, and that's regardless of who controls Congress.

There's a bipartisan recognition right now in D.C. – of AI as a strategic priority, particularly given competition with China. But at the same time, we are seeing growing political resistance at the state and local levels, where concerns around electricity prices, water usage, and infrastructure costs are becoming increasingly important.

So, where that all nets out, what we've been describing is a base case of a conditional build-out. The investment cycle continues, but both the pace and the geographic distribution of new projects could become more dependent on local policy decisions. And that distinction matters for investors exposed to utilities, power generation, and the broader AI infrastructure supply chain.

So, Monica, how are you thinking about that issue specifically for wealth management clients?

Monica Guerra: I think it's a really good example of how a national political issue can have very local investment implications. For individuals, the concern often begins at home with the electricity bill. But it can also have implications for local issuers and the municipal bond market – dependent on whether a community and local government captures the benefits of new investment or absorbs the infrastructure costs.

And that's why we've been emphasizing the importance of following what state and local governments are actually doing rather than just reacting to every move out of Washington. The same applies for taxes, which is another area where we're getting a lot of questions.

Ariana Salvatore: Yeah, let's talk about that because taxes are probably the clearest example of how the near-term and longer-term implications can differ. [Of] course, at the federal level, we don't expect a change in congressional composition to meaningfully reverse the tax policies enacted last year through the OBBA.

The president will remain in the Oval Office for the next two years. That means that he retains veto authority, which from a mechanical perspective just creates a significant hurdle to major legislative changes. But at the same time, the midterms could start to lay the groundwork for a different tax debate heading into 2028 and [20]29, specifically around AI and the build-out.

For markets, expectations can start changing well before legislation actually arrives.

Monica Guerra: Exactly. And for individual investors, there's also a very important state level dimension. We're watching proposals involving wealth taxes, property taxes, and state income taxes, all of which could have implications for household financial planning and the muni[cipal] bond market.

So even if federal tax policy remains relatively stable – which we think it will – investors still need to be attentive to potential changes that are closer to home.

And I want to come back to that broader market implications for a moment and really dig into that with you, Ariana. Are there particular areas where you think investors could be underestimating the impact of the election?

Ariana Salvatore: I think the biggest risk is actually assuming that [a] divided government automatically means less policy volatility. Typically, the blueprint here is divided government means gridlock. That constraint is actually clarity for markets, which can be a good thing. But in this case, of course, even if a change in congressional control occurs, you might see additional oversight investigations and political scrutiny – but executive action can continue.

And that could matter at the margin for sectors like technology and energy, which we've highlighted in terms of both the antitrust angle and deregulation more broadly. But I'd also distinguish between headline risk and actual changes to earnings or the macro-outlook.

Not every political development is going to translate to a meaningful market impact, which is why we see this election as more of a micro than a macro catalyst.

Monica Guerra: I agree, and from the wealth management perspective, that's why we really emphasize discipline. And lean into the idea that negative policy headlines often doesn't equal negative fundamentals.

Election outcomes can change the policy backdrop and create sector-specific opportunities or risks. That individual investors should be careful about allowing short-term political developments to drive long-term asset allocation decisions.

Ariana Salvatore: So maybe to wrap up, Monica, what's one thing that you'd encourage individual investors to watch after November 3rd?

Monica Guerra: Yeah. I'd focus on the policy decisions that actually affect households and portfolios, especially energy costs and state and local developments. And I'd encourage investors to work with their advisors distinguishing meaningful policy change from that political noise.

How about you?

Ariana Salvatore: Well, from my perspective, I think there's a lot to watch in this lame duck period. Of course, the fiscal calendar, so government funding, potentially addressing the debt limit. We've got the NDAA, that's the bill that funds the Pentagon, coming due in December. You've got potential U.S.-China meetings.

So, plenty to watch, I'd say, between now and the end of the year.

But maybe just to kind of put a through line through all this, our broader takeaway is that the midterms probably won't alter fundamentally the direction of U.S. policy. But they could change where risks emerge and how quickly certain priorities can move forward.

So, for investors, the important question isn't just who wins in November, it's actually what changes as a result.

Monica, thanks for joining me.

Monica Guerra: Thanks, Ariana. Great speaking with you.

Ariana Salvatore: And thanks for listening. If you enjoy the show, please leave us a review wherever you listen and share Thoughts on the Market with a friend or colleague today.

Monica Guerra is a member of Morgan Stanley’s Wealth Management Division. She is not a member of Morgan Stanley’s Research Department. Unless otherwise indicated, her views are her own and may differ from the views of the Morgan Stanley Research Department and from the views of others within Morgan Stanley.