Wall Street is betting on a split congress with U.S. midterms on tap

The building consensus for a split Congress creates a risk of a major swing in the stock market if expectations suddenly swerve toward a sweep by either party. Photo by Michael M. Santiago/Getty Images

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The United States midterm election season has entered its final stretch, and Wall Street is busy drawing up game plans for a range of scenarios. Yet, in a fortuitous turn of events, the best outcome for markets is also looking like the likeliest one.

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Investors have become increasingly confident that Democrats will take the House of Representatives in November, while assigning a slight edge to Republicans in the Senate. To many market watchers, this is the ideal setup with the least risk of disruptive policies.

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While confidence in that outcome is not unfounded, it’s far from guaranteed. Democrats are by far the prediction markets’ favourites to take control of the House. The Senate race, however, has grown tighter, with Republicans currently narrowly ahead on Kalshi and Polymarket.

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“Investors are expecting a split Congress,” said Brian Gardner, chief Washington policy strategist at Stifel. “If that is the outcome and Democrats kind of do what they have to do to win the House but don’t have a wave election, I could see a bit of a relief rally after that.”

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In the meantime, Wall Street is bracing for some jitters around the midterm elections. The futures market tied to the Cboe Volatility index, or VIX, is showing signs of higher demand to protect against volatility in the S&P 500 index in early November.

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Evercore ISI recommends traders to position for potential swings in the market through a so-called straddle on the State Street SPDR S&P 500 ETF Trust. The options strategy that allows traders to benefit from big moves — both up and down — without making a directional bet would involve buying both bullish and bearish options expiring in November with a strike price of US$770.

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That position is attractively priced because the VIX is sitting well below its long-term average, despite the potential for big-picture forces to push stocks higher or lower, said Julian Emanuel, a strategist at the firm. “Surprise is drastically underpriced.”

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When it comes to election results, Wall Street’s thinking is that with different parties at the helm in the two chambers, the likelihood of drastic policy changes — be it in artificial intelligence, defence or health care — will be lower. That would mean less uncertainty for the markets.

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A divided Congress has been a welcome development for U.S. stocks in the past. Under a Republican president and a split Congress, U.S. stocks have advanced 13.7 per cent a year since 1950, data compiled by Carson Investment Research show. That compares with a gain of 8.3 per cent and 4.9 per cent when the Congress was controlled by Republicans and Democrats, respectively.

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AI has steadily risen to prominence as one of the standout issues of this election season, amid growing backlash against data centre buildouts. That has forced investors to reckon with rising regulatory risks around the technology at the epicentre of a four-year bull run in U.S. stocks.