Signals to Watch in the U.S. Midterms

Monica Guerra · Morgan Stanley Wealth Management

Affordability is the defining midterm issue, leaving the incumbent party in a challenging environment.

Monica argues affordability has become the defining issue for voters this cycle. Her signal monitor tracks four indicators: the generic ballot, presidential approval, consumer sentiment and gasoline prices. Democrats lead the generic ballot by about eight points. Presidential approval is 38.8%, below the 40% reference point where the opposition tends to gain. October consumer sentiment is the lowest for any pre-midterm October in the University of Michigan survey's history. September gasoline prices were up 37.6% year over year. Persistent inflation, high borrowing costs and Iran-related energy pressure weigh on purchasing power. She notes these are directional indicators, not an outcome forecast.

“So taken together, these signals point to a challenging environment for the incumbent party, really driven by affordability.”at 1:28

Ariana Salvatore · Morgan Stanley

Midterms are unlikely to fundamentally change US policy direction, since market uncertainty has come from the executive branch.

Ariana's firm view is that the midterms won't fundamentally change the direction of US policy. The basis is that most policy uncertainty markets have faced since early 2025 has come from the executive branch rather than Congress. She expects tariffs, deregulation, immigration, geopolitics and export controls to remain important sources of policy uncertainty regardless of the election outcome.

“Because our view has been that the midterms are unlikely to fundamentally change the direction of US 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.”at 1:55

Monica Guerra · Morgan Stanley Wealth Management

Assuming divided government means less policy volatility is the biggest risk for investors.

Monica argues that investors may underestimate policy volatility after the election. The common view is that divided government means gridlock, and gridlock brings clarity for markets. Ariana adds the caveat that oversight investigations and political scrutiny can rise even if Congress changes hands, and executive action can continue. That matters for technology and energy, where antitrust and deregulation are live issues. Monica treats assuming less volatility as the key mistake.

“I think the biggest risk is actually assuming that divided government automatically means less policy volatility.”at 6:28

Ariana Salvatore · Morgan Stanley

The election is a micro, not macro, catalyst; headline risk often won't change earnings or the macro outlook.

Ariana separates headline risk from real changes to earnings or the macro outlook. Not every political development will have a meaningful market impact. She therefore sees this election as more of a micro catalyst than a macro one. She adds that oversight investigations may follow a change in congressional control, but executive action can continue. That could matter at the margin for technology and energy, through the antitrust and deregulation angles already highlighted.

“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.”at 7:08

Ariana Salvatore · Morgan Stanley

Divided government would make fiscal legislation harder to pass, bringing contentious fights over funding, debt limit and defense.

Ariana argues that congressional control matters most for fiscal policy, unlike other policy areas. A divided government would make new legislation harder to pass. That would likely produce more contentious negotiations over government funding, the debt limit and defense spending. She frames this as the main way the midterm outcome matters for policy.

“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.”at 2:23

Ariana Salvatore · Morgan Stanley

Midterms may start shaping a 2028-29 tax debate on AI and buildout; markets will price expectations early.

Ariana expects no meaningful federal tax reversal from a change in Congress. The president keeps veto power for the next two years, which creates a big hurdle to major tax changes. The midterms could still start a different tax debate heading into 2028 and 2029, focused on AI and the buildout. Markets can reprice expectations well before any legislation arrives, so tax risk is a forward-looking issue for investors.

“But at the same time, the midterms could start to lay the groundwork for a different tax debate heading into 2028 and '29, specifically around AI and the build out. For markets, expectations can start changing well before legislation actually arrives.”at 5:54

Monica Guerra · Morgan Stanley Wealth Management

Narrow breadth plus tech and energy strength could amplify policy-driven volatility as the index runs ahead of history.

Monica notes the S&P 500 has averaged about a 14% return in the calendar year after a midterm, versus roughly 3% in the midterm year. This year the index has already outperformed that typical second-year path. She argues that recent strength in technology and energy, combined with narrow breadth, could amplify policy-related volatility, especially in industries facing heightened scrutiny under the new Congress. She stresses this is not a forecast and warns against trading on historical election patterns.

“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.”at 3:17

Ariana Salvatore · Morgan Stanley

AI buildout avoids federal prohibition, but its pace and locations will depend on state and local policy.

Ariana's view is that the AI infrastructure buildout is unlikely to face broad federal prohibition, whoever controls Congress. Bipartisan support for AI as a strategic priority, given competition with China, supports that. Local resistance is growing over electricity prices, water use and infrastructure costs. Her base case is a conditional buildout: the investment cycle continues, but the pace and geography of projects depend more on local decisions. That matters for utilities, power generation and the AI supply chain.

“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.”at 4:32

Monica Guerra · Morgan Stanley Wealth Management

Local data-center policy could affect municipal bond issuers, depending on who captures benefits and who pays costs.

Monica argues that the electricity-cost and data-center issue has local investment effects. Households first feel it through electricity bills. It can also affect local issuers and the municipal bond market. The outcome depends on whether a community and its local government capture the benefits of new investment or absorb the infrastructure costs. That is why she says investors should follow what state and local governments actually do.

“For individual, the concern often begins at home with the electricity bill, but it can also have implications for local issuers and the municipal bond market, depending on whether a community and local government captures the benefits of new investment or absorbs the infrastructure costs.”at 5:02