2026 Midterm Election Review
Democrat Gains
Democrats made significant gains in this week’s midterm elections, with estimates (as of Wednesday morning) pointing to 40 to 45 House pickups and several additional Senate seats, reflecting a broad shift across demographic groups and regions. The results are consistent with the historical tendency for the president’s party to lose ground in midterms, but also continue a broader pattern of political volatility: this marks the tenth election in the past 11 in which voters have removed the party in power at the federal level. These frequent shifts in political control have contributed to greater uncertainty on the direction and durability of policy, a dynamic that will remain important this cycle. Democratic control of Congress could bring renewed scrutiny of recently-enacted tax incentives, including those benefiting data centers and other capital investment, while an approaching debt-ceiling deadline could provide additional leverage in negotiations with the administration. A larger Democratic majority in the Senate could also increase the prospects for bipartisan coalitions on select issues where some Republicans diverge from the White House. Starting now, the focus shifts from the election results themselves to how the new balance of power could reshape the policy agenda over the next two years.
AI and Data Centers
This truly was a data center election in most of the big data center states, and I think there has been a massive disconnect between investors and voters on sentiment around data centers. Let’s start here: Senator Wyden, who will be the Senate Finance Committee Chairman, put out a plan this year that would remove the 100% expensing for data centers and also impose an excise tax. But there is far from a consensus at the federal level. Senator Warner, who represents data center-heavy Virginia, has a proposal that allows data centers to keep tax benefits if they meet environmental requirements. There are already media leaks of similar discussions between environmental groups and business groups, but this is a major issue with voters and there are wide gaps to bridge to get everyone on the same page.
This is the sixth midterm election since Baird Strategas opened its doors in 2006 and we’ve never said gubernatorial races are more important than Congress for stocks. But that is what is shaping up this election cycle because of data centers and the state and local levels they’re governed from. For instance, Virginia held its gubernatorial election last November. The state raised energy taxes on data centers in June, which was followed by an immediate pulling of the largest data center project in the state. Amazon pulled four zoned data center projects in Virginia two weeks ago. Capex forecasts for Virginia are lower today than before the election. We would expect a similar policy outcome in other states that flipped this election cycle. If you apply that model across many states, it will start to impact capex forecasts and, ultimately, earnings. Now, a lot of that bad news is priced in – data center stocks have dramatically underperformed since this summer – but headline risk remains.
Healthcare
Healthcare was not a big part of this campaign, but we believe it will be the number one policy initiative for the Democrats. The first thing that you'll see is House Resolution 1. We envision that will be a comprehensive healthcare bill, which will focus on clawing back the Medicaid cuts that were passed in the One Big Beautiful Bill, restoring the ACA subsidies that went away for ~4 million people, expanding the National Institute of Health (NIH) budget, etc. Investors may be caught off guard is by the aggressiveness of what we'll see on the pharmaceutical side in terms of government intervention to lower prices. Even if a lot of the wishes don’t get passed because they’d require 60 votes in the Senate, it will create some headline risk for a sector that has been a nice defensive hedge against AI volatility.
We've been very out of consensus in our view that stuff can get done next year if the Democrats sweep. And the reason is that the Democrats will have complete control of the government and they will have the budget to use as leverage with the president. They could offer continued spending on the Iran war, with a cost such as Medicaid cuts being reinstated, renewable energy tax credits, NIH spending, etc. Those are the areas you would likely have to see some sort of compromise to be able to get a budget, and I think healthcare will be a big component of it. This is not new. In 2006, despite running against the Iraq war, House Democrats still approved money for defense spending, but in exchange got a minimum wage increase, children’s health insurance, student loan reform, etc.
Fiscal
Our big policy theme coming into 2026 was “Shock and Awe” economic policy with more than $500 billion of fiscal policy via the One Big Beautiful Bill (OBBB) and tariff relief. Fiscal policy was coupled with the Fed balance sheet expanding and the GSEs purchasing mortgage-backed securities (MBS) that were rolling off the Fed’s balance sheet. A surprise arrived when the courts mandated $150 billion of tariff refunds earlier in 2026 than our estimates suggested. This $700 billion stimulus provided a cushion from the Iran geopolitical shock and the rise of oil to $100 per barrel. But as the calendar turns to 2027, it is very difficult to keep this level of stimulus in place…and some of the tide of stimulus has already turned.
More specifically, the Federal Reserve is raising interest rates and is no longer expanding its balance sheet. Tariff refunds are just about completed and the final piece of the replacement plan for IEEPA tariffs is set to come into effect. Consumers will still receive their tax refunds, but the incremental gains are declining. We expect the 2027 boost from OBBB to be about $200 billion smaller than this year’s gain. There will likely be some offsets. Defense spending has not increased despite the large cost of the Iran War. At some point, we expect Defense accounts to be replenished. The election is also an “affordability” election and we would expect some budget deal mid-year that will address health care and food costs, provide limited tariff and even renewable energy relief, and help offset the headwinds in the back half of 2027.
As such, the outlook for capex and specifically data centers seems particularly important. We noted earlier that the politics of data centers has shifted, and that could result in less capex down the road. The Fed needs to be mindful of this when thinking about interest rates. In 2000, Y2K ended and the Fed was still raising rates, was caught with policy too tight as the equity market fell, and was doing an emergency 50 basis point rate cut six months after its last rate increase.
Iran
Ultimately, there's not much to say. In many ways, this result is a rebuke of the Iran war, although we believe the tariffs had a bigger impact. Even President Trump himself said higher oil prices and the Iran war impacted this election. There will be votes in Congress to end the Iran war, and we think those votes are likely going to pass. So, that opens a short window for the president to decide how he wants to proceed. Iran still has plenty of retaliation capability right now and will continue to use those retaliation capabilities if the U.S. is going to attack. And that's why there's a lot of debate internally at the White House around continuing to apply economic pressure and continue to be creative in how to get oil out of the Gulf.
In Conclusion
Midterm election years have tended to be relatively bad for stocks, with an average intra-year decline of 19% for the S&P 500. That is very different in years 1, 3, and 4 of the presidential cycle, which have an average intra-year decline of 12-13%. Something always happens in the midterm election year. War in Ukraine (2022), Trump’s trade war (2018), Ebola (2014), and Financial Regulation (2010) are recent examples. Fortunately, all of these events tended to be temporary, with no recession ever hitting in the third year of the presidency. In fact, the S&P 500 has not declined in the 12 months following a midterm election since 1938. Just getting to the midterm election has been the key point for investors.
But sometimes, the large, pre-election correction does not occur. This was true during Trump’s first term and again today. The 2018 post-midterm election correction was a painful -19% decline into Christmas, which eventually rebounded quickly in 2019. The story then was as follows: a new Fed Chair (Powell) tightening financial conditions, Trump and Xi fighting over what was said in their meeting, and Democrats vowing to shut down the government in December. Today we have a similar set up. A new Fed Chair trying to get his footing and government funding running out in early December. But instead of Trump and Xi fighting, today we have data center opposition and geopolitical tensions with Iran. Seasonals are usually good around this time, but there is no shortage of headline risk. We’ll continue to monitor the landscape and keep an ear to the ground in Washington.
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