With a Democratic takeover of Congress threatening to reshape policy priorities, hedge fund managers are looking beyond the election outcome to assess mispriced risks and opportunities across AI, credit and fixed income.
Elections often play a peripheral role for markets. Barring shock results, markets price in potential outcomes months in advance while fiscal assumptions about the post-election landscape are already set. For hedge funds, the upcoming midterm elections are no different: Democrats currently have a 91% chance of controlling the House and a 64% chance of controlling the Senate, according to Kalshi’s latest reading.
Securing both houses could lead to a seismic rewiring of the current status quo. This lingering uncertainty has been affecting markets in recent weeks; the whipsawing AI trade, bond market turbulence and frequent sector rotation reflect investors searching for a haven to latch onto. A premium highly valued in the post-election landscape. Analysis from Oppenheimer Asset Management noted that, since 1948, midterm years have averaged a 5% S&P 500 gain compared with 11.2% in the other three years of the presidential cycle.
Despite recent turbulence, Elliott Hentov, Chief Macro Policy Strategist at State Street Investment Management, believes hedge funds have already positioned themselves for the initial election repercussions. “Barring a left-field decision, all other outcomes are largely priced in at this stage. Headline deficits are also expected to remain range-bound given little appetite or political incentives for fiscal consolidation.” With the baseline already countenanced, managers are looking beyond the result for the implications on credit spreads and treasury yields.
The national debt hitting $40tn has done little to deter Republicans from administering tax cuts and handing out fiscal benefits. A Democratic victory in both the House and the Senate could leave the party emboldened to pursue more of its domestic agenda, including “pushing to reinstate green energy/EV credits and subsidies for Medicaid and food stamps,” according to Christopher Hodge, Chief US Economist at Natixis CB Americas. There is likely to be greater scrutiny, inquiries and special reports into decisions that have already been taken, in turn creating equity volatility for companies in adjacent sectors. For funds, distinguishing headline noise from the long-term trajectory is where alpha will be generated.
In this dynamic, the AI buildout and its relationship with the public and private sectors will be front and centre. Questions surrounding the technology are bifurcated. The support that Democratic candidates, such as Sherrod Brown in Ohio, have cultivated by attacking data centres for raising utility bills may be harnessed to push for greater regulation of the environmental fallout and societal impact they have on local populations. If pushback continues credit investors could be hurt, as greater regulatory requirements would necessitate additional capex investment and more hurdles to clear, extending the time before returns materialise.
Conversely, applying some brakes to the buildout could have a galvanising effect in the long term. LLM hallucinations, capex concerns and broader questions about adoption and use cases have placed equities under significant pressure to justify their meteoric rise, a tension exacerbated by market concentration in these stocks. Clear and fair development guidelines may encourage broader and faster adoption of the technology across industries, helping to offset hyperscalers’ expenditure concerns and settle equity valuations. Chloe Autio, CEO of Autio Strategies, adds, “Voters want policymakers to respond to local concerns without necessarily abandoning the economic opportunities associated with data center investment.” Going long AI equities and not diversyfing to the point where returns dilute, is likely to reap the rewards.
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One manager trying to interpret this dynamic is Bonnie-Lyn De Bartok, Chief Investment Strategist at LION-S. De Bartok is certainly astute to the idea of not pulling the rug on the AI theme: “We are assessing the potential outcomes by asking where political dependence becomes financial vulnerability.” In that sense, De Bartok is determining where “greater scrutiny” from greater Democratic influence translates into “operating constraints, delayed investments or higher costs” for AI companies. Long/short opportunities will reveal themselves in how different facets of the AI ecosystem absorb the initial pressure and external shocks that may come. Basil Qunibi, CIO of Atom Investors, adds, “The opportunity is not necessarily in predicting the political outcome. It is in identifying companies whose earnings, competitive positions and valuations may be affected very differently by the same policy change.”
AI is a central tenet of the midterm discussion and something for investors to contend with. As Autio adds, “people aren’t concerned about data centers. People are concerned about how data centers might affect their energy bills, water costs, utility prices, and access to resources.” In that regard, the macroeconomic picture remains unclear. The Trump administration’s ongoing interventions in the Middle East continue to put pressure on consumer prices. A blue wave in Congress may stymie the domestic and foreign policy agenda, with cost-of-living pressures thrust further into the spotlight, but only to a certain extent, as Hodge explains: “There isn’t an economically focused legislative agenda President Trump wants to implement and most of his policy priorities can be done via executive power. There will be more oversight, more subpoenas, more noise, but not much in the way of a policy shift.”
For bond investors, this could be a difficult environment to navigate. Policy stasis, coupled with the potential for Trump to bypass Congress, means balancing competing trade-offs. In recent weeks, lagging equity valuations have seen government bonds become a haven once more. Funds are also navigating the continuation of tariffs by the administration, which feed into inflationary pressures and weigh on growth, making the yield picture lopsided, as new debt becomes more attractive while existing holdings depreciate in value.
Qunibi notes that the “second- and third-order consequences have been difficult to navigate,” a view echoed by industry juggernaut Ken Griffin, who recently lambasted the administration’s trade stance. “Tariff battles with Canada, Europe and our allies have just been a disaster,” he said, underscoring how isolated the President has become on the issue, even with the relief that tariff refunds have provided.
De Bartok explains why the picture is so blurred for funds: “A tariff can protect a producer while squeezing its customers; an infrastructure incentive can encourage construction without resolving power, workforce, or community constraints.” In this environment, relative value strategies, which target price discrepancies rather than follow broad market direction, look increasingly attractive to hedge funds. The point was crystallised when trend-followers suffered a rout during the recent tech sell-off.
The midterms are unlikely to mark a definitive turning point for markets, as policy uncertainty and intense competition for capital will persist. Funds that can maintain liquidity and anticipate ripple effects across asset classes may hold a defining advantage, since second-order consequences can prove as significant as the policies themselves.