Signals to Watch in the U.S. Midterms — Transcript

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1. 0:00Welcome to Thoughts on the Market.
2. 0:01>> [music]
3. 0:02>> I'm Mariana Salvador, head of US Public
4. 0:03Policy Research at Morgan Stanley.
5. 0:05>> And I'm Monica Guerra, head of Policy
6. 0:07and Geopolitical Strategy for Morgan
7. 0:09Stanley Wealth Management.
8. 0:11>> Today we're going to [music] be talking
9. 0:12about the upcoming midterm elections and
10. 0:14what investors should be watching from
11. 0:15both an institutional [music]
12. 0:17and individual investor perspective.
13. 0:19It's Wednesday, October 28th at 10:00
14. 0:22a.m. [music] in New York.
15. 0:24Well, election day is just about a week
16. 0:26away. Investors are obviously
17. 0:27increasingly focused on what a potential
18. 0:29change in congressional control could
19. 0:31mean for markets. And Monica, you and I
20. 0:33are kind of grappling with this question
21. 0:35through slightly different lenses and
22. 0:36that's why I thought it would make sense
23. 0:37to bring you in today. We both agree
24. 0:39that what happens after the election is
25. 0:40probably more important than the outcome
26. 0:42itself. But let's start with the
27. 0:44election backdrop. Your team has
28. 0:46developed a midterm signal monitor. What
29. 0:47are the indicators telling us?
30. 0:49>> Well, Ariana, affordability has really
31. 0:51emerged as the defining issue for voters
32. 0:53this cycle. Our monitor tracks four
33. 0:55indicators positively correlated with
34. 0:57midterm election outcomes, the generic
35. 0:59congressional ballot, presidential
36. 1:00approval, consumer sentiment, and
37. 1:02gasoline prices.
38. 1:04Democrats lead the generic ballot by
39. 1:06about eight points and presidential
40. 1:08approval is 38.8%
41. 1:11just below the 40% historical reference
42. 1:13point when the opposition political
43. 1:15party tends to gain momentum. Now,
44. 1:17consumer sentiment in October is the
45. 1:19lowest of any October before a midterm
46. 1:21election in the University of Michigan
47. 1:23Survey's entire history. And gasoline
48. 1:25prices in September were up 37.6% from a
49. 1:28year ago. So, taken together, these
50. 1:30signals point to a challenging
51. 1:32environment for the incumbent party,
52. 1:34really driven by affordability.
53. 1:36Persistent inflation, elevated borrowing
54. 1:38costs, and renewed energy price
55. 1:39pressures tied to the conflict with Iran
56. 1:41are all weighing on household purchasing
57. 1:43power. But importantly, these are
58. 1:46directional indicators, not necessarily
59. 1:48a forecast of the election outcome
60. 1:50itself. Now, Ariana, when you're looking
61. 1:52at the potential outcomes from your
62. 1:54perspective, how much do you actually
63. 1:56expect to change?
64. 1:57>> Well, I think that's the key question,
65. 1:58right? Because our view has been that
66. 1:59the midterms are unlikely to
67. 2:01fundamentally change the direction of US
68. 2:03policy.
69. 2:04And that's because a lot of the
70. 2:05uncertainty that markets have dealt with
71. 2:07since the beginning of 2025 has come
72. 2:09from the executive branch rather than
73. 2:11Congress.
74. 2:12So, regardless of the outcome, we think
75. 2:14things like tariffs, deregulation,
76. 2:16immigration, geopolitics, export
77. 2:18controls, all of those variables will
78. 2:20remain important sources of policy
79. 2:22uncertainty.
80. 2:23Where congressional control matters more
81. 2:25is on fiscal policy. So, a divided
82. 2:27government would make new legislation
83. 2:29harder to pass, and that could mean more
84. 2:31contentious negotiations over things
85. 2:33like government funding, the debt limit,
86. 2:35and defense spending. So, for
87. 2:37institutional investors, it's a little
88. 2:39bit less about which party wins and more
89. 2:41about what the composition of Congress
90. 2:43means for the policy agenda going
91. 2:44forward, as well as leadership's ability
92. 2:47to really organize and corral different
93. 2:49members of the caucus to effectively use
94. 2:52their leverage around some of these
95. 2:53negotiations. So, Monica, I imagine the
96. 2:55questions that you're getting from
97. 2:56individual investors may be a little bit
98. 2:58different. Talk us through some of
99. 2:59those.
100. 3:00>> Yeah, they are. I think the biggest
101. 3:01question is what the election can mean
102. 3:03for an individual's portfolio. And
103. 3:05history does offer us some interesting
104. 3:07perspective here. So, the S&P 500 has
105. 3:09averaged about a 14% return in the
106. 3:11calendar year following a midterm
107. 3:13election, compared with roughly just 3%
108. 3:15in the midterm year itself. And this
109. 3:17year, as we all know, the index has
110. 3:19already outperformed that typical
111. 3:20second-year trajectory, which could
112. 3:22heighten risks and opportunities for
113. 3:24sectors sensitive to policy decisions.
114. 3:26For example, recent strength in
115. 3:28technology and energy, combined with the
116. 3:30narrow market breadth, could amplify
117. 3:33policy-related volatility, particularly
118. 3:35in industries facing heightened scrutiny
119. 3:37under the new Congress.
120. 3:39Of course, that's not a forecast, and we
121. 3:41caution against making portfolio
122. 3:43decisions based on historical election
123. 3:45patterns or political headlines alone.
124. 3:47As a business cycle, corporate earnings,
125. 3:49inflation, interest rates, and the AI
126. 3:51investment cycle are likely to matter
127. 3:52much, much more over the long run. But
128. 3:54one area where I do think our
129. 3:56perspectives really intersect is the
130. 3:58growing focus on electricity costs and
131. 4:00data centers.
132. 4:01>> That's right. And it's actually one of
133. 4:02policy themes that we've been
134. 4:03highlighting the most into the election.
135. 4:06Our view is that the AI infrastructure
136. 4:07build-out is unlikely to face broad
137. 4:09federal prohibition, and that's
138. 4:11regardless of who controls Congress.
139. 4:13There's a bipartisan recognition right
140. 4:14now in DC of AI as a strategic priority,
141. 4:17particularly given competition with
142. 4:19China.
143. 4:20But at the same time, we are seeing
144. 4:21growing political resistance at the
145. 4:23state and local levels where concerns
146. 4:25around electricity prices, water usage,
147. 4:28and infrastructure costs are becoming
148. 4:30increasingly important.
149. 4:32So, where that all nets out, what we've
150. 4:33been describing is a base case of a
151. 4:35conditional build-out. The investment
152. 4:37cycle continues, but both the pace and
153. 4:39the geographic distribution of new
154. 4:41projects could become more dependent on
155. 4:43local policy decisions.
156. 4:45And that distinction matters for
157. 4:47investors exposed to utilities, power
158. 4:49generation, and the broader AI
159. 4:50infrastructure supply chain. So, Monica,
160. 4:53how are you thinking about that issue
161. 4:54specifically for wealth management
162. 4:55clients?
163. 4:56>> I think it's a really good example of
164. 4:57how a national political issue can have
165. 4:59very local investment implications. For
166. 5:02individuals, the concern often begins at
167. 5:04home with the electricity bill, but it
168. 5:06can also have implications for local
169. 5:08issuers and the municipal bond market
170. 5:10depending on whether a community and
171. 5:12local government captures the benefits
172. 5:14of new investment or absorbs the
173. 5:15infrastructure costs. And that's why
174. 5:17we've been emphasizing the importance of
175. 5:19following what state and local
176. 5:21governments are actually doing rather
177. 5:22than just reacting to every move out of
178. 5:24Washington. The same applies for taxes,
179. 5:27which is another area where we're
180. 5:28getting a lot of questions.
181. 5:29>> Yeah, let's talk about that because
182. 5:30taxes are probably the clearest example
183. 5:32of how the near term and longer term
184. 5:35implications can differ. Of course, at
185. 5:37the federal level, we don't expect a
186. 5:38change in congressional composition to
187. 5:40meaningfully reverse the tax policies
188. 5:42enacted last year through the OBBA.
189. 5:44The president will remain in the Oval
190. 5:46Office for the next 2 years. That means
191. 5:48that he retains veto authority, which
192. 5:50from a mechanical perspective just
193. 5:51creates a significant hurdle to major
194. 5:53legislative changes.
195. 5:54But at the same time, the midterms could
196. 5:56start to lay the groundwork for a
197. 5:58different tax debate heading into 2028
198. 5:59and 2029, specifically around AI and the
199. 6:02build-out. For markets, expectations can
200. 6:05start changing well before legislation
201. 6:07actually arrives.
202. 6:08>> Exactly. And for individual investors,
203. 6:10there's also a very important state
204. 6:12level dimension. We're watching
205. 6:13proposals involving wealth taxes,
206. 6:16property taxes, and state income taxes,
207. 6:18all of which could have implications for
208. 6:20household financial planning and the
209. 6:22muni bond market. So, even if federal
210. 6:24tax policy remains relatively stable,
211. 6:26which we think it will, investors still
212. 6:29need to be attentive to potential
213. 6:30changes that are closer to home.
214. 6:32Now, I want to that broader market
215. 6:34implications for a moment and really dig
216. 6:36into that with you, Ariana. Are there
217. 6:38particular areas where you think
218. 6:40investors could be underestimating the
219. 6:41impact of the election?
220. 6:43>> I think the biggest risk is actually
221. 6:44assuming that divided government
222. 6:45automatically means less policy
223. 6:47volatility. Typically, the blueprint
224. 6:49here is divided government means
225. 6:51gridlock. That constraint is actually
226. 6:53clarity for markets, which can be a good
227. 6:55thing. But in this case, of course, even
228. 6:57if a change in congressional control
229. 6:59occurs, you might see additional
230. 7:00oversight investigations and political
231. 7:02scrutiny, but executive action can
232. 7:04continue. And that could matter at the
233. 7:06margin for sectors like technology and
234. 7:07energy, which we've highlighted in terms
235. 7:09of both the antitrust angle and
236. 7:11deregulation more broadly.
237. 7:13But I'd also distinguish between
238. 7:14headline risk and actual changes to
239. 7:17earnings or the macro outlook. Not every
240. 7:19political development is going to
241. 7:20translate to a meaningful market impact,
242. 7:22which is why we see this election as
243. 7:24more of a micro than a macro catalyst.
244. 7:27>> I agree. And from the wealth management
245. 7:29perspective, that's why we really
246. 7:30emphasize discipline and lean into the
247. 7:33idea that negative policy headlines
248. 7:36often doesn't equal negative
249. 7:38fundamentals.
250. 7:39Election outcomes can change the policy
251. 7:41backdrop and create sector-specific
252. 7:42opportunities or risks, but individual
253. 7:44investors should be careful about
254. 7:46allowing short-term political
255. 7:47developments to drive a long-term asset
256. 7:50allocation decisions.
257. 7:51>> So, maybe to wrap up, Monica, what's one
258. 7:53thing that you'd encourage individual
259. 7:55investors to watch after November 3rd?
260. 7:57>> Yeah, I'd focus on the policy decisions
261. 7:59that actually affect households and
262. 8:01portfolios. Especially energy costs and
263. 8:04state and local developments. And I'd
264. 8:06encourage investors to work with their
265. 8:08advisors distinguishing meaningful
266. 8:10policy change from that political noise.
267. 8:12How about you?
268. 8:13>> Well, from my perspective, I think
269. 8:14there's a lot to watch in this lame duck
270. 8:16period. Of course, the fiscal calendar,
271. 8:18so government funding, potentially
272. 8:20addressing the debt limit. We've got the
273. 8:22NDAA, that's the bill that funds the
274. 8:23Pentagon, coming due in December. You've
275. 8:26got potential US-China meetings. So,
276. 8:28plenty to watch, I'd say, between now
277. 8:30and the end of the year. But, maybe just
278. 8:32to kind of put a a through line through
279. 8:33all this, our broader takeaway is that
280. 8:35the midterms probably won't alter
281. 8:37fundamentally the direction of US
282. 8:39policy, but they could change where
283. 8:41risks emerge and how quickly certain
284. 8:43priorities can move forward. So, for
285. 8:45investors, the important question isn't
286. 8:47just who wins in November, it's actually
287. 8:48what changes as a result. Monica, thanks
288. 8:51for joining me. Thanks, Ariana. Great
289. 8:53speaking with you.
290. 8:55And thanks for listening. [music]
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