Gridlock and diplomatic hopes lift US stocks

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What happened?
The S&P 500 closed 1.6% higher on Wednesday, reversing the initial negative reaction in futures markets to the Democrats taking control of both the House of Representatives and the Senate in the US.

The Nasdaq Composite gained 1.4%, while the 10-year US Treasury yield fell 8bps from its level before the election result. The US dollar weakened against most other major currencies, with the DXY dollar index down 0.5%.

Hopes for progress toward ending the US-Iran conflict also supported market sentiment. Qatar has stepped up mediation efforts following signs that Washington and Tehran are seeking to resume talks. Iranian officials, however, sounded less optimistic about a deal, reiterating that an agreement would only be possible if the US accepts Iran’s seven points. Brent crude oil fell 8.2% overnight, and has since stabilized around 95/bbl, as investors assess whether diplomacy could reduce the risk of further disruption to energy supplies.

Still, overall risk sentiment remains fragile in early Thursday trading, with AI-heavy indices in South Korea and Taiwan down 5.3% and 3.2%, respectively, and Nasdaq futures pricing a 0.5% decline at the time of writing.

What do we think?
The election result has removed a source of uncertainty. With Democrats controlling both chambers of Congress and President Donald Trump retaining the presidency and veto power, abrupt changes to tax and spending policy should be more difficult to enact.

While this is not a forecast of future performance, the S&P 500 gained an average of 15.5% in the six months following the previous 14 midterm elections since 1970. This pattern may partly reflect the removal of election uncertainty and investors’ tendency to refocus on the economic and earnings outlook.

Political risks remain, however. The next Congress will need to address government funding and the debt ceiling, potentially increasing bond market volatility. Democratic gains in key data center states could also delay projects, raise development costs, or influence capacity location. Trump retains broad executive authority over tariffs, foreign policy, and regulation.

Individual stock performance is already beginning to reflect these differences in exposure. On Wednesday, large technology platforms performed strongly, while some companies linked to data center construction declined. Investors were concerned that Democratic gains in states including Texas and Georgia could lead to greater scrutiny of electricity consumption, water use, and permitting.

Investors appear to favor financially strong platforms that can fund investment flexibly from existing cash flow. They are becoming more cautious about businesses exposed to financing, construction, permitting, or execution risks. This suggests that broad equity gains may be accompanied by greater dispersion in technology sector performance.

Overall, the election does not change our view that economic growth, corporate earnings, inflation, and interest rates should remain the primary market drivers. Earnings remain supportive, with recent corporate results providing further evidence of robust demand
across parts of the technology sector and the broader economy.

Prospects for US-Iran diplomatic progress offer another potential source of stability. Both sides have incentives to avoid a prolonged conflict that keeps energy prices elevated and increases economic pressure. However, global inventories have fallen sharply, and pledged releases from strategic oil reserves are largely complete. Continued undersupply could further deplete commercial stocks and support oil prices. Record freight costs, constrained tanker capacity, and recovering Chinese imports are also likely to keep prices elevated.

Comments from Trump that no military strike is imminent have helped weigh on prices, but the risk of renewed military action leaves markets vulnerable to further energy price volatility, while open questions remain on how long the US will support energy flows with military escorts.

How do we invest?
We remain constructive on global equities, but the uneven rally and uncertainty surrounding US-Iran negotiations reinforce the importance of diversification.

Stay invested in diversified equities. Strong earnings, resilient economic growth, and robust demand for AI infrastructure continue to support our constructive view. Our preferred sectors include industrials, health care, and financials. Regionally, we prefer the Eurozone, emerging markets, and Asia ex-Japan.

Rebalance concentrated technology exposure. Greater scrutiny of data centers, alongside existing questions about AI monetization, could increase single-stock volatility. Investors with oversized positions in individual securities should use periods of strength to reduce concentration and diversify across the AI value chain. We favor financially strong platforms and high-quality infrastructure providers over businesses that rely more heavily on external funding or the rapid completion of individual projects.

Maintain protection against geopolitical disruption. Diplomatic progress could push down oil prices further, but renewed attacks or a breakdown in negotiations could trigger another rise. Broad commodity exposure can help diversify portfolios when geopolitical disruption weighs on both stocks and bonds. Investors should consider exposure across energy, precious metals, industrial metals, and agriculture, rather than rely on a single commodity or geopolitical outcome.