Beyond the ballot box: the real drivers of post-election market

Of course, elections are not irrelevant. Changes in government can shape fiscal policy, regulation, and investor sentiment. However, for long-term investors, the key issue is often not which party wins, but whether the election increases policy volatility, changes the broader economic backdrop, influences interest rates, or alters corporate earnings prospects.

In our view, the coming midterms are unlikely to become a decisive turning point for markets. Instead, they may drive shifts in performance across sectors and styles, while the fundamental drivers of return will remain interest rates, earnings growth, and the continuing evolution of the AI investment cycle.

Political headlines can move markets in the short term, but uncertainty is often more important than any specific electoral outcome, explaining why we may see a rotation into defensive positions as more clarity on policy direction is awaited.

Indeed, markets frequently become more constructive after elections, as the reduction in uncertainty can lower the equity risk premium demanded by investors and support a recovery in appetite for riskier assets.

Current polls and prediction markets suggest a realistic possibility of divided government in Washington, with control potentially split between the Democrats and Republicans. From a market perspective, divided government has often been viewed favourably as the likelihood of major legislative changes tends to fall and policy volatility is reduced. Fewer significant policy shifts can mean greater predictability and a more stable backdrop for businesses and investors.

While this does not imply stronger economic growth or better earnings per se, markets are certainly more comfortable operating in an environment where the rules of the game appear stable. And even if the Democrats were to sweep Congress, the outcome may still be constructive for markets, depending on the degree of policy clarity going forward.

While political developments attract attention, investors should not lose sight of a variable that has consistently exercised a great influence over equity prices in recent years: interest rates. The ultimate market impact of any election outcome is likely to depend on whether it changes expectations for inflation, and fiscal and monetary policies. Any shift that increases inflationary pressures could reinforce expectations for higher interest rates. Conversely, a more moderate fiscal backdrop could ease inflation concerns and support lower yields.

These dynamics matter because they influence the relative attractiveness of different parts of the equity market. Higher inflation and interest rates have historically tended to favour shorter-duration equities, including many value-oriented and income-generating businesses. Such companies derive a greater share of their valuations from near-term cash flows and are therefore less sensitive to higher discount rates. Lower inflation and lower rates, in contrast, have typically been more supportive of longer-duration growth companies whose expected earnings are weighted further into the future.

What thus matters most is the extent to which the outcome of the election affects the path of inflation and interest rates. Politics may be the trigger, but rates remain the transmission mechanism through which many market effects are ultimately felt.

While politics dominates media coverage, investors should remember that companies ultimately create value through earnings, not election results. Indeed, the upcoming earnings season may prove more important than the election. Strong corporate results could help underpin market resilience regardless of the political outcome. Conversely, disappointing earnings could increase market sensitivity to political developments and amplify volatility.

This is particularly relevant given the high expectations embedded in parts of the market. Investors will be looking not only at earnings growth but also at management commentary on demand trends, capital expenditure plans, and the outlook for AI-related investments. History suggests that political events often create noise while earnings provide the foundation for long-term returns. That lesson may prove instructive in the months ahead.

The temptation during election years is to focus on winners and losers. Yet investors may be better served by asking a different question: will there be substantive policy changes, and what will they mean for the market environment? Our view is that the overall impact on markets may be less dramatic than many expect. Rather than triggering a major shift in the market’s direction, the election is more likely to influence where market gains are concentrated.

Investors may rotate between defensive and cyclical exposures, between value and growth styles, and between regions as they reassess the outlook for inflation, interest rates and policy stability. Indeed, Europe and Asia may be beneficiaries; the former if investors seek greater diversification away from US equities or rotate towards regions with less direct exposure to election-related headlines, while several Asian economies have historically responded positively when investors perceive lower policy volatility in Washington.

Ultimately, the most important determinants of market performance are likely to remain the same: the path of interest rates, the strength of corporate earnings, and the continued development of the AI investment cycle. Politics will undoubtedly dominate the headlines. But when the dust settles, investors may once again discover that policy volatility matters more than politics, and that fundamentals matter more than either.