US Midterms: Short-Term Market Jitters Ahead, but Long-Term Outlook Steady, says Morgan Stanley
Morgan Stanley predicts short-term volatility due to US midterm elections but says long-term economic outlook remains steady.
As the United States prepares for its upcoming midterm elections, investors are bracing for potential turbulence. According to a recent report by Morgan Stanley, while the US midterm elections market impact may manifest as short-term volatility—especially if results are delayed—the fundamental long-term economic trajectory of the country is unlikely to shift significantly.
The Political Forecast: A Divided Government?
Morgan Stanley has provided a detailed outlook on the political landscape, predicting that Democrats are likely to regain control of the US House of Representatives. The report also revised its stance on the Senate, moving from a "Republican hold" to a "toss-up," though it notes a slight edge for the Democrats.
The shift in the Senate race is attributed to two primary factors affecting voters:
- Rising costs of living.
- Weakening consumer sentiment.
The analysts suggest that this could lead to a "divided government," a scenario that typically restricts the ability to pass major legislative overhauls regarding government spending, regulations, and tax laws.
Market Performance and Historical Trends
Looking at history, the report highlights how the S&P 500 Index has behaved following midterms under a Republican president. On average, the index gained:
- 16% when Democrats controlled both chambers of Congress.
- 23% when control of Congress was split between the two parties.
However, Morgan Stanley warns that the current environment is different. Because US equities have already seen strong performance in 2026—outpacing the typical second year of a presidential term—there may be "less room" for significant gains immediately following the elections.
Sector-Specific Risks: Tech and Energy
While the broader market may remain stable, certain sectors could feel the heat. The report flags that technology and energy stocks might face pressure due to increased regulatory scrutiny and the possibility of reduced government support.
Specifically, the AI boom is not immune to political headwinds. Morgan Stanley notes that growing opposition to data centers could lead to project delays. This may trigger short-term price swings for stocks tied to AI infrastructure, although the firm believes this will not necessarily damage their long-term prospects.
The Big Picture: Interest Rates and Deficits
One of the most critical takeaways from the report is that the election alone is unlikely to fundamentally alter the US fiscal deficit or the long-term outlook for interest rates. The "gap" between what the government spends and what it earns remains a structural issue.
The report points out several economic pressures:
- Bond Yields: Heavy government borrowing and increased Treasury issuance could drive bond yields higher, which in turn puts pressure on asset prices.
- Fiscal Reform: While spending cuts could lower borrowing, a significant reduction in the fiscal deficit would require comprehensive tax and spending reforms—something that is notoriously difficult to achieve under a divided government.
"A close election or delayed results could cause short-term market volatility, but a delay alone would be unlikely to change the longer-term forces driving markets," the report concludes.
Ultimately, Morgan Stanley suggests that investors should keep their eyes on inflation, corporate earnings, and overall economic growth, as these factors will remain the primary drivers of market performance, far outweighing the immediate outcome of the polls.