Bank of America Hartnett: A Democratic midterm sweep will crash US stocks and burst the AI bubble.

Michael Hartnett, chief investment strategist at Bank of America Securities, warned that soaring global bond yields to 20-year highs are becoming the biggest threat to the AI capital spending boom, and the upcoming US midterm elections could be the trigger for a market meltdown.

In the latest issue of the Flow Show weekly report, Hartnett pointed out that if the Democrats sweep both houses of Congress in the midterm elections, US stocks will face a drop of more than 10%, the dollar will weaken, bond yields will decline, and the AI bubble will face the risk of bursting. He characterized a "Democratic sweep" as one of the biggest tail risks in the current market, which investors have hardly priced in at all.

Polymarket data shows that the probability of a Democratic sweep of both houses of Congress has risen to 50%, far higher than the 10% probability of a Republican sweep. President Trump's approval rating is currently hovering between 35% and 40%, significantly lower than the historical average of 53% two months before a midterm election. This political fundamental is reinforcing Hartnett's warning logic.

The bond market was the first to sound the alarm.

Hartnett believes that the most noteworthy event in the market last week was not the better-than-expected employment data, but the complete collapse of the global bond market.

The 10-year US Treasury yield rose to 4.81%, approaching levels seen during the 2008 financial crisis; the 30-year US Treasury yield rose to 5.31%, the highest since 2007. Meanwhile, the yield on 10-year Japanese government bonds broke through 3.0%, the first time since 1996; the 30-year yield reached 4.2%, approximately four times the Bank of Japan's policy rate. In Europe, the yield on 10-year German government bonds rose to 3.38%, a new high since 2011; the spread between French and German yields widened to 88 basis points, and the spread between Italian and German yields reached 84 basis points, both approaching levels seen during the 2012 European debt crisis. The Bloomberg Global Bond Yield Index has risen to its highest level since 2007, just one percentage point away from its highest level this century.

Hartnett distills this phenomenon into his core judgment: "Bonds are driving the bubble." He believes that long-term yields—rather than the stock narrative—are the true anchor for current AI trading, and points out that until global 30-year yields fall below 5%, builders and investors of AI infrastructure will continue to underperform those who apply AI technology.

Midterm Elections: An Underestimated Market Variable

Hartnett acknowledged that the midterm elections were not "regime change" elections like the 1980 Thatcher/Reagan elections or the 2016 Brexit/Trump elections, and would not fundamentally alter the upward trajectory of US government spending. However, he emphasized that the structural differences in the election results would have a significant impact on asset prices.

A Bank of America survey of fund managers in August showed that 47% of respondents expected a Republican-controlled Senate and a Democratic-controlled House, 23% expected a Democratic sweep, and only 9% expected Republicans to retain control of both houses. Currently, Republicans lead 53-47 in the Senate and 218-212 in the House.

In the Senate race, for the Democrats to achieve a sweep, they must win at least four of the six weak Republican seats: North Carolina (92% chance of a reversal), Maine (69%), Alaska (64%), Ohio (55%), Texas (51%), and Iowa (37%). They must also retain their own weaker seats in Georgia (94%), New Hampshire (84%), and Michigan (65%). Hartnett specifically names Ohio, Texas, Iowa, and Michigan as key battleground states that investors should closely monitor.

Of particular note is that Wall Street has turned its attention to the Texas gubernatorial election—the contest between incumbent Republican Governor Abbott (49% approval rating) and Democratic challenger Hinojosa (45%), which is seen as a key indicator of the direction of AI data center expansion policies. Abbott was recently forced to announce a halt to data center construction in an effort to stem his declining poll numbers.

The market impact path of the Democratic sweep

Hartnett provides a clear transmission logic for the market impact under a Democratic sweep scenario.

He believes that if the electoral landscape shifts from "populist capitalism" to "populist socialism," it means that the direction of taxation and regulation will change from downward to upward, negatively impacting corporate profits. This will be accompanied by policy orientations such as suppressing inflation, improving healthcare accessibility, and alleviating K-shaped wealth disparity, directly impacting the AI capital expenditure boom and the "too big to fail" Wall Street ecosystem. Furthermore, the loss of Trump's political capital will weaken his ability to implement policies on priority issues such as AI, resource monopolies, and diplomatic pressure.

Based on the above assessments, Hartnett's asset allocation recommendations for a Democratic sweep scenario are: shorting financial stocks and the US dollar as the optimal hedging tools; the stock market will fall by more than 10%, the US dollar will weaken, and bond yields will decline; international stock markets will outperform, with Europe outperforming Asia.

Conversely, if the Republicans unexpectedly retain control of both houses of Congress, it would signify a general rise in risk appetite, a green light for the AI bubble, and a resurgence of the dollar's "exceptionalism" narrative. The most probable scenario, of "Republicans controlling the Senate and Democrats controlling the House," corresponds to a moderate risk appetite—"a stalemate is like a blonde bombshell."

Strategic allocation: Long commodities and gold, beware of AI-driven congested trading.

Within the aforementioned macroeconomic framework, Hartnett maintains his core cross-cycle allocation recommendation: go long on commodities and gold as hedges against inflation and geopolitical risks. He points out that governments' "whatever it takes" fiscal intervention is suppressing long-term yields and supporting nominal GDP growth, and in this context, the strategic logic that "any asset is better than bonds" still holds true.

In the realm of AI trading, Hartnett's warnings are even more direct. He points out that the free cash flow of hyperscale cloud computing vendors has turned negative under pressure from capital expenditure commitments, and the AI bubble "could burst at any time." He proposes a post-bubble trading framework of "going long on humiliation and short on arrogance," suggesting a shift towards long-term bonds and defensive sectors, including consumer staples, mining/materials, and healthcare, while avoiding crowded AI infrastructure-related stocks.

From a long-term perspective, Hartnett also noted a contrarian signal: the 10-year rolling return for US stocks was 15%, commodities 11%, while US Treasury bonds were -2%, marking their worst performance in nearly a century. Historical data shows that negative long-term bond returns often present good buying opportunities for stocks (1939, 1974, 2009) and commodities (1933, 2018), providing historical basis for his tactical bullish view on Q4 bonds.

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