Insight & Outlook: Fidelity Market Signals Weekly

The Midterm Effect: For markets, resolution matters more than results

Uncertainty leading up to elections can influence investors, but fundamentals and policy details matter more than the results at the polls.

A difficult run-up, a stronger follow-through

Midterm election years have historically brought heightened volatility. In the last 85 years, the S&P 500 has experienced an average midterm-year drawdown of approximately 18%. Yet the index posted positive returns over the 12 months following every midterm election since 1942. So far this year, despite a bout of volatility in March following the attacks in Iran, markets have remained resilient and experienced a peak-to-trough decline of only approximately 9% in March.

Why resolution may matter more than the vote

For investors, the outcome suggests that the resolution of the midterm is much more important for the markets’ long-term trajectory. Election-related volatility does not necessarily signal deteriorating fundamentals. Markets discount an unknown distribution of policy outcomes into the vote and then reprice from a known outcome. The political outcome seems to matter far less than the end of the pre-election uncertainty. Across 21 midterms since 1942, broad market returns over the subsequent six months were similar irrespective of congressional configurations, according to Fidelity’s analysis. One possible explanation is that a known result narrows the range of policy possibilities, allowing investors to look beyond the vote.

A flip in control may not mean new policy outcomes

Similar index-level outcomes can still mask meaningful sector differences. Financials, health care, industrials, energy, and defense remain particularly sensitive to policy developments. A divided government would likely reduce legislative activity as the administration advances its regulatory agenda and Congress shifts toward oversight and investigations. Even so, lawmakers could continue to elevate issues such as credit card regulation, health care costs, drug pricing, tax and regulatory proposals. While Democratic proposals would face significant legislative hurdles, including a potential presidential veto, they could help shape future policy debates. Investors may also be watching how the election outcome affects year-end must-pass legislation, including but not limited to government funding, the National Defense Authorization Act,¹ and tax extenders.

The more useful question is how proposed legislation would affect revenue, costs, or cash flows for companies. Broad sector labels can obscure offsetting effects—and mask vastly different prospects for companies within the same industry.

Investment themes that extend beyond Election Day

Other investment themes depend less directly on the balance of power in Congress. The artificial intelligence (AI) buildout remains primarily a corporate-spending and productivity story, spanning semiconductors, data-center infrastructure, software, and digital platforms. Outcomes of gubernatorial races may determine the speed of data center buildout, but the key distinction for investors is delay versus cancelation. Nevertheless, investors need to be more selective in positioning across the AI theme, as heavy capital requirements, higher financing costs, and uncertain returns on spending remain important risks.

National security, supply-chain resilience, domestic manufacturing, and infrastructure tied to existing appropriations may also prove durable across election outcomes. But bipartisan support does not eliminate budget or regulatory risk, and long-term demand does not guarantee attractive investment returns.

Durability and selectivity can coexist. Even when a structural theme persists across election outcomes, individual companies can face very different earnings, financing, and execution challenges.

What does this mean for investors?

Elections can influence short-term volatility and industry prospects without determining the long-term market trajectory. History offers perspective on election uncertainty, not a promise of a post-election rally. The distinction for investors is straightforward: Acknowledge material policy risks while staying grounded in fundamentals.