Quick Thoughts: Bluer Than Blue—Investment Implications

The 2026 midterm elections have delivered a significant political shift, with Democrats projected to control both the House of Representatives and the Senate, along with important gubernatorial victories in Texas, Georgia, Ohio and Iowa. Although not all results are in and the final congressional margins remain uncertain, the implications for President Trump's remaining two years in office are substantial. For investors, the key questions concern legislative gridlock, fiscal policy, interest rates and the prospects for industries ranging from artificial intelligence (AI) to cryptocurrencies.

• Affordability is a key issue. The cost of living was a dominant factor in this election, with voters expressing concerns about housing, health care, energy and everyday expenses. The conflict with Iran, higher energy prices and tariffs have contributed to these pressures. The results suggest that affordability will remain a central political issue through 2028. Both parties have incentives to address these concerns, potentially creating opportunities for bipartisan initiatives involving housing, infrastructure and energy costs. For investors, affordability will influence consumer spending, corporate margins, inflation expectations and Federal Reserve policy. Companies perceived as contributing to higher prices may also face increased regulatory and political scrutiny.
• Gridlock: Markets are usually up the year after midterms. History suggests investors should not necessarily fear divided government. Franklin Templeton Institute research covering the nine midterm elections from 1990 through 2022 found that the S&P 500 Index gained an average of 14.5% during the following 12 months, with positive returns in all nine periods. Markets have historically benefited as election uncertainty recedes and attention returns to fundamentals. However, gridlock should not be confused with fiscal discipline. A Democratic Congress will constrain major new tax and spending legislation, but substantial federal deficits and Treasury issuance are unlikely to disappear. The immediate market reaction has included declines in equity futures and Treasury yields, reflecting uncertainty about regulation and future fiscal policy. Longer-term interest rates will remain particularly important for equity valuations, housing, real estate and the financing of infrastructure investment. Historical returns are not a guarantee of future performance.
• AI and data centers: An increasingly political investment theme. The expansion of AI infrastructure became an important election issue, particularly in states where data centers have contributed to concerns about electricity prices, water consumption and infrastructure costs. Democratic gubernatorial victories in Texas and Georgia are especially noteworthy, as both states are important locations for data-center development. The incoming Texas governor has advocated restricting new projects until developers bear more of the associated infrastructure costs. However, concerns about data-center economics and electricity affordability extend across party lines. The election is unlikely to reverse the structural demand for AI infrastructure, but it could change where facilities are built, how quickly projects proceed and who pays for the necessary infrastructure. Power generation, transmission, electrical equipment and grid infrastructure should remain important investment opportunities, although developers and utilities could face increased regulatory costs and construction delays.
• Investment impact—Industries most affected. Elections tend to have a greater influence on the relative performance of industries than on the overall direction of financial markets. Health care companies could face increased scrutiny over drug pricing, insurance costs and reimbursement policies. Financial institutions may encounter tougher congressional oversight, while defense contractors could face changes in spending priorities. Energy companies, including renewable-energy developers, may be sensitive to permitting decisions, regulation and federal incentives.
• Cryptocurrencies deserve particular attention. Republican control of Washington had supported expectations for a more favorable regulatory environment for digital assets. Democratic control of Congress could complicate further market-structure legislation and lead to increased scrutiny of cryptocurrency exchanges, decentralized finance and investor protections. The CLARITY Act failed to advance in the Senate in September, and the new congressional composition may make agreement on comprehensive legislation more difficult. However, the GENIUS Act, which established a federal framework for payment stablecoins, remains law. Bitcoin and other cryptocurrencies declined as the election results emerged, reflecting investor concerns about the regulatory outlook. Near-term volatility may increase, but greater regulatory clarity over time could support institutional adoption, tokenization and the development of digital financial infrastructure. For investors, the distinction between speculative crypto assets and the longer-term investment opportunities associated with blockchain technology remains important.
• Governors' races may have a greater investment impact than expected. Democratic victories in Texas, Georgia, Ohio and Iowa represent important changes in state leadership. Governors and state regulators exercise significant influence over electricity pricing, utility investment, infrastructure permitting, economic development and taxation. Their decisions may have more immediate consequences for AI infrastructure and energy investment than changes in congressional control. State policy will also influence manufacturing investment, industrial development and the availability of incentives for new facilities. Municipal bond investors should pay particular attention to state fiscal policies, infrastructure spending and credit quality. Differences in tax policies, demographic trends and economic growth could create attractive opportunities for active management across state and local bond markets. These elections reinforce the importance of evaluating investment conditions at the state level rather than treating US policy as a single national issue.
• A tougher Trump? With Democrats controlling both chambers of Congress, President Trump will face greater legislative constraints, congressional oversight and potentially more investigations. Democratic control of the Senate will also complicate judicial and other presidential appointments requiring confirmation. However, the president retains considerable executive authority over tariffs, trade, immigration, sanctions and foreign policy, subject to legal constraints. This could encourage greater reliance on executive actions rather than legislation. Congressional budget negotiations and debt-ceiling discussions may also become more contentious. For investors, divided government may reduce the likelihood of sweeping legislative changes without necessarily reducing policy uncertainty. Indeed, greater confrontation between Congress and the White House could increase volatility, particularly for companies exposed to international trade, government spending and regulatory decisions.
• What is different this time? Several factors distinguish the 2026 midterms from previous elections. First, the AI investment boom has become a major contributor to economic growth, corporate earnings and equity-market performance, while simultaneously creating new political tensions around electricity demand and affordability. Second, geopolitical uncertainty, particularly the conflict with Iran, has added pressure to energy markets and inflation. Third, substantial federal deficits, elevated Treasury yields and a Federal Reserve that has resumed raising interest rates present a more challenging environment for both equities and fixed income. As discussed in a recent Franklin Templeton Institute Quick Thoughts commentary on bond markets, the increase in Treasury yields has been driven predominantly by higher real interest rates rather than inflation expectations. Higher real yields increase the cost of capital and could weigh on economic growth and corporate earnings in 2027. Meanwhile, equities have already benefited from strong earnings growth and substantial AI-related investment. The election is likely to create greater dispersion among industries and individual companies rather than fundamentally alter the long-term drivers of financial markets. Earnings growth, real interest rates and the sustainability of the AI investment cycle should remain more important than the political composition of Washington.

And now on to 2028... Attention will quickly turn to the next presidential election. With President Trump constitutionally limited to two terms, both parties will begin positioning their prospective candidates, and the Democratic victories in Congress and several key governorships will influence the political landscape. Affordability, economic growth, trade, energy policy and America's leadership in AI are likely to remain central issues. The next two years could bring increased political confrontation and shifting policy expectations, but investors should remember that markets are ultimately driven more by earnings, economic fundamentals and interest rates than by election outcomes. The challenge will be to distinguish political noise from policy changes that materially affect investment returns—and to recognize the opportunities that political uncertainty can create.

Source for all data cited: Bloomberg; Analysis by Franklin Templeton Institute. Past performance is not an indicator or a guarantee of future results.