Could the US midterms cause a surprise stock market rally?

Investors have a lot on their plate. Oil, inflation and interest rates are climbing, while tech stocks are volatile amid growing fears of an AI bubble.

Throw in US President Donald Trump's unpredictability, mounting government debt, regional wars and stretched stock valuations, and it’s all getting a bit much. Now comes another challenge: Americans go to the polls on November 3 for the midterm elections, which will determine control of Congress and the direction of Mr Trump's presidency.

Yet here’s a curious twist. History shows that midterm elections have typically been followed by a strong run for Wall Street. JP Morgan Asset Management’s analysis shows the S&P 500 has risen in the 12 months following every midterm since 1950. Might history repeat itself?

If so, stock market bulls have plenty to look forward to, says Russ Mould, investment director at AJ Bell. “The past is no guarantee, but the third year of a presidential term is, on average, the best one for the US stock market.”

The average third-year gain across postwar presidencies is a stellar 16.1 per cent. No other presidential year averages a double-digit gain, he says.

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Why the midterms matter outside the US

One theory is that presidents have an incentive to boost the economy ahead of the next election. Another is that the midterms often deliver a lame-duck president who struggles to pass legislation, allowing businesses to operate without interference from Washington.

Markets are often volatile before the vote, but when the result is known, investors can focus on policy rather than polling, says Jason Hollands, managing director at Evelyn Partners.

Gridlock could boost stocks

Mr Trump looks on course to lose control of both the House and Senate. If that happened, it could actually help stocks. “A divided Congress would make major new legislation harder to pass. That could limit the prospect of sweeping changes to areas such as tax and regulation,” Mr Hollands says.

But investors shouldn’t assume divided government means quiet government. Aliasgar Tambawala, co-chief investment officer at Klay Group, warns that political gridlock brings problems of its own. “A divided legislature may lead to greater disruptions around issues such as the debt ceiling and government funding.”

Mr Trump's executive powers, including tariffs, would remain largely intact, while the President retains his veto.

Mr Tambawala expects political volatility to persist, but says GCC investors face bigger concerns, notably the situation in the Strait of Hormuz. “A durable resolution would augur well for the region.”

Despite recent volatility, the S&P 500 and tech-focused Nasdaq are up around 12 per cent this year, says Tony Hallside, chief executive of STP Partners. Further gains depend on earnings.

“Getting the election out of the way helps sentiment, but it does not create earnings growth. If inflation persists or profits fall short of expectations, the historical election pattern will offer little protection.”

AI is another concern. Can the technology justify the huge sums being invested by generating sustainable revenue and profits? “Political clarity will not compensate for disappointing commercial results,” Mr Hallside says.

Reality checks for investors

Madhur Kakkar, chief executive of Elevate Financial Services, warns that markets face formidable headwinds. Brent crude has hit $117 a barrel, the US Federal Reserve raised interest rates in September and may do so again in December, while 10-year Treasury yields are approaching 5 per cent.

“Higher Treasury yields give investors a competitive income alternative at a time when US equity valuations remain demanding,” Mr Kakkar says. The S&P 500's Shiller price-to-earnings ratio ended October at 40.88, a level exceeded only during the dot-com boom.

On October 29, Alphabet shares plunged 13 per cent, wiping $500 billion off its value after heavy AI infrastructure spending contributed to negative quarterly free cash flow of $9.1 billion. Yet the US economy remains resilient, with third-quarter GDP growing at an annualised 3.4 per cent. Mr Kakkar urges investors to maintain balanced portfolios rather than chase a post-midterms rally.

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HSBC backs Gulf growth amid global investment push

Vijay Valecha, chief investment officer at Century Financial, believes AI and interest rates, rather than politics, will determine whether markets finish 2026 strongly. “Easing inflation and a successful Anthropic IPO could still fuel a year-end rally.”

For the GCC, the outlook is firmer than headline figures suggest, he says. The IMF expects Gulf output to shrink 4.8 per cent this year because of the Iran war, before rebounding 9.1 per cent in 2027.

Saudi Arabia and the UAE are shipping substantial oil volumes around the Strait of Hormuz, while high crude prices bolster revenue. Non-oil activity remains strong, but a full recovery depends on the strait reopening, which the IMF assumes will begin in March 2027.

Mr Mould remains cautious. Inflation is sticky, interest rates may rise, the Middle East war could drag on, oil and equity valuations are high, and the AI boom could end in an investment bust.

History suggests the midterms could unleash another Wall Street rally. But with so many risks stacking up, investors may discover that this time, history really is bunk.