Morgan Stanley released a report analyzing how the Democratic Party's decisive victory in the midterms will affect the market. The firm believes that the Democrats' overwhelming win in the U.S. midterms could reshape fiscal policy and lead to increased scrutiny of infrastructure investments related to AI, but it maintains its overall outlook for the macroeconomy and the market remains unchanged.

Core Points

• Democratic victories in state elections, especially in Texas, may lead to stricter data center regulations and delays in related projects, but the long-term investment cycle of AI is not expected to change.
• A change in control of Congress could potentially delay or weaken the planned cuts to medical assistance ( Medicaid ) and food stamps ( SNAP ), which is expected to support consumer spending and economic growth.
• Morgan Stanley's research team maintains a bullish view on global equities, with supporting arguments including economic resilience, improving corporate earnings, and the continuous advancement of AI investments.
• It is highly likely that the trade and geopolitical policies at the presidential executive level will continue; however, adjustments to healthcare policies and increased AI regulations will affect the performance of specific sectors.

The Democratic Party has taken control of both the Senate and the House of Representatives in Congress, and also won governorships in several traditionally Republican states. The election results have raised concerns in the market: how will policies change, and what impacts will they have on economic growth, financial markets, and various assets?

For investors, one of the most important changes is the increasing expectation of stricter regulation on data center development, which may suppress investment sentiment in AI. At the same time, with Democrats in control of Congress, there is hope for a readjustment of the federal healthcare and food subsidy cut plans, which is beneficial for the healthcare sector and consumer spending.

Analysis suggests that there are three key policy areas worth monitoring in the short term, which are also likely to become central issues in the 2028 general elections, with the corresponding market impacts as follows:

I. Fiscal Policy: Changes to Medical Assistance and Food Stamp Cuts Plans

The "Great Beauty Act" ( OBBBA ) plans to cut approximately $900 billion in medical assistance spending and $200 billion in food stamp program ( SNAP ) budgets over the next decade.

Now that the Democratic Party controls both the Senate and the House of Representatives, some of the proposed cuts may be postponed, weakened, or even overturned in subsequent fiscal negotiations. The large majority of seats held by the Democratic Party also helps to bridge internal divisions and advance legislation around limited priorities.

Even if the reduction plan is implemented, Morgan Stanley estimates that the federal fiscal deficit will still remain around 6%, which is GDP.

II. Presidential Executive Power Dominates Policy: Uncertainty is Likely to Continue

A great deal of policy uncertainty during Trump's second term stems from executive orders rather than congressional legislation.

With the Democratic Party in control of Congress, it is difficult to make substantial changes to the current administration's stance on geopolitics, export controls, deregulation, and trade, including the upcoming review of the US-Mexico-Canada Agreement ( USMCA ). Therefore, investors should still be prepared for policy fluctuations, especially in areas where the president retains significant executive power.

III. AI Infrastructure: Data centers face greater regulatory risks

The election results add new variables to the infrastructure investment of AI; the newly appointed state government officials may introduce regulations for data center management.

Approval powers for data center grid connection, large industrial electricity prices, site selection, tax exemptions, and reductions are mostly in the hands of state public utility commissions, state legislatures, and county councils. Regulatory policies vary from state to state: some regions continue to welcome the establishment of new data centers, while others have tightened restrictions.

The Texas governor election is particularly crucial. The victory of Democratic candidate Gina Hinojosa significantly increases the risk of project delays, as her campaign platform includes a pause on approving new data centers.

Although such news may suppress the sentiment in the AI sector in the short term, Morgan Stanley believes that the long cycle of capital expenditure in AI will not be interrupted.

The U.S. economy is expected to see room for improvement.

Setting aside policy changes, Morgan Stanley maintains its assessment that the U.S. economy has resilience and inflation will continue to decline; the election results may even bring additional benefits to economic growth.

The postponement or reduction of medical assistance and food stamp programs could improve household cash flows and boost consumption, providing a modest boost to the economy; at the same time, the issuance volume of U.S. Treasury bonds with maturities of 2 to 7 years may increase slightly.

Overall, with the Democrats controlling both chambers of Congress, it is essentially hopeless that the Republican version of the budget reconciliation bill will be passed after the new Congress takes office in January. This eliminates the main upward risk of a further surge in the U.S. government debt financing needs.

Current Views on Various Assets

US Stocks: Short-term volatility, long-term support is positive

Historical patterns show that U.S. stocks generally perform well after mid-term elections. Since 1982, large-cap stocks have averaged a gain of 15% to 16% within six months following mid-term elections, with an annual increase of about 22%.

The market had previously priced in the Democrats winning both chambers of Congress, with a narrow majority in the Senate. However, the extent of the Democratic victory, especially in the race for Governor of Texas, exceeded expectations and is likely to cause volatility in the short term. Nevertheless, this round of uncertainty may mark the concluding phase of the pullback that began this summer.

Other risks include renewed hostilities from Iran and additional tariffs imposed by the United States.

Investment Strategy: Continuing to Prefer Global Stocks

After the mid-term elections, Morgan Stanley remains optimistic about global equities and underweights core bonds, continuing to increase its position in equities while underweighting core fixed income. AI Continuous investment is expected to boost corporate earnings, supporting markets in Europe, America, and emerging markets.

Bond views remain largely unchanged. Even as investors become more cautious regarding AI, companies will continue to borrow to invest in digital infrastructure. Apart from AI, oil prices and the debt issues of multiple governments will continue to dominate stock and bond markets and their correlations, and this US election will not change this logic.

Foreign Exchange: Safe-haven currencies are dominant

The two main themes in foreign exchange market pricing are: doubts about the investment prospects of AI, increased opposition from Congress to geopolitical conflicts, and rising risks associated with targeted trade measures.

Short-term bias towards hedging trades: The Japanese yen, Swiss franc, and euro are expected to strengthen relative to the US dollar; the Australian dollar is weaker, as its performance is highly tied to the risk appetite represented by AI.

US healthcare sector: Good news for insurance companies that rely on medical assistance

Insurance companies that focus on Medicaid business are expected to benefit from the Democratic Party's major victory; comprehensive insurance companies are likely to have a relatively lukewarm response.

After gaining control of the congressional agenda, the Democratic Party has more room to advance its healthcare proposals, such as reinstating subsidies under the Affordable Healthcare Act and reversing the healthcare cuts implemented by the Republican Party, including the work requirement provisions. The likelihood of a major healthcare bill being passed before the next presidential election remains low, but public opinion has shifted, with several key supporters of Trump's healthcare policies having left their positions.

Responsible Editor: Chen Yujia