With the US midterm elections approaching, Wall Street is betting on a divided Congress, and the market may be getting a mild respite.

As the US midterm elections enter their final stretch, Wall Street is increasingly viewing a "divided Congress" as the baseline scenario, believing that this outcome could be a relatively mild policy result in the current market environment.

According to Bloomberg, investors widely expect Democrats to regain control of the House of Representatives in November, while Republicans will retain control of the Senate, albeit with a limited majority. The market believes this scenario will reduce the likelihood of major policies being implemented quickly, forcing both parties into more deadlocks or compromises on various issues, thereby alleviating policy uncertainty.

In a report to clients, Stuart Kaiser, head of U.S. equity trading strategy at Citigroup, said that a “ divided government” would “force both sides into a stalemate or seek compromise,” leading to more moderate policy options and “allowing the stock market to focus on corporate and economic fundamentals.”

Meanwhile, markets are also preparing for volatility before and after the election. Futures markets linked to the Chicago Board Options Exchange Volatility Index (VIX) show a significant increase in demand for volatility protection against the S&P 500 index in early November.

A divided Congress may be the "optimal solution" for the market.

Historical data supports Wall Street's optimistic expectations. Data compiled by Carson Investment Research shows that since 1950, when Republican presidents were in power and Congress was divided between the two parties, the average annual increase in U.S. stocks was 13.7%; in contrast, when Congress was controlled by either the Republicans or the Democrats, the average annual increase in U.S. stocks was only 8.3% and 4.9%, respectively.

Brian Gardner, chief Washington policy strategist at Stifel, said: “Investors are anticipating a divided Congress. If that’s the case, with Democrats winning the House but not overwhelmingly, I think there could be some loosening of the grip.”

Artificial intelligence has also become one of the most talked-about issues in this midterm election. As the backlash against data center construction continues to intensify, investors are forced to confront the rising regulatory risks facing this core technology that has driven the four-year bull market in US stocks.

In a divided government, the likelihood of disruptive policy changes in fields such as artificial intelligence, defense, and healthcare will be significantly reduced, which is the core logic behind the market's view of it as the "most positive outcome."

If a "one-party sweep" occurs, the market may experience severe volatility.

However, the high degree of consensus in the market regarding a divided Congress also poses a potential risk—if the final outcome deviates significantly from expectations, the stock market may face severe volatility.

It's not impossible for Democrats to win both houses of Congress. While Trump remains the Republican Party's biggest mobilizing force, his record-low approval ratings are becoming a major drag on the party. Republicans are pinning their hopes on a midterm election campaign informally dubbed "Trumpapalooza" to avoid repeating the disastrous defeat during Trump's first term.

According to Bloomberg, a team led by Bank of America strategist Michael Hartnett pointed out last month that a strong Republican performance and a successful re-election of Texas Governor Greg Abbott would significantly boost AI-related trading; conversely, a Democratic victory in the Senate and Abbott's defeat would lead to a "sharp decline" in the stock market.

Phil Wool of Rayliant analyzed that a Republican sweep would benefit sectors that benefit from further deregulation, with energy and finance being potential beneficiaries; while a Democratic "blue wave" could drive up the prices of renewable energy and healthcare service providers.

Institutions have taken precautions in advance, and long-term strategies still prevail.

Although the market is preparing for the election results in advance, not all institutions believe that the midterm elections will be enough to change long-term investment strategies.

Omar Aguilar, CEO of Schwab Asset Management, stated that while political outcomes always unsettle clients, most election results have limited real impact on long-term market trends. He acknowledged that short-term volatility in specific sectors may increase, but believes this should be viewed as an opportunity to adjust portfolios rather than a signal to change the overall strategy.

“Customers are definitely watching, just like they watch $100 oil prices,” Aguilar said. “But does that mean they have to change their strategy? Our advice has always been: no, just stick with what you have.”

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