by Frank Holmes, CEO, CIO, U.S. Global Investors
Tuesday’s midterms were one for the history books. Democrats won control of both the House and Senate, and they picked up governorships in Ohio, Texas and Georgia. Kansas elected a Democrat to the Senate for the first time since 1932. Our home state of Texas did so for the first time in 38 years.
Voters were clearly focused on their wallets. Heading into the election, diesel averaged $6.34 a gallon, gasoline $4.23 and 30-year mortgage rates about 7.4%, according to CLSA. Even Vice President JD Vance said the war with Iran was the main reason Republicans lost.
Government policy is a precursor to change, so I asked my research team to dig into what the new lineup in Washington could mean for investors. When Congress is sworn in on January 3, a Republican president will face a Democratic House and Senate for the first time since George W. Bush’s final two years in office.
The Hard Part May Be Behind Us
Midterm years have historically been the toughest stretch of the four-year presidential cycle. Since 1944, the S&P 500 has averaged a gain of just 3.8% in midterm years, compared with 10.9% in the other three years, according to JPMorgan. Midterm years have also seen the deepest average drawdowns, at 18%.
This year has bucked the trend, with the S&P 500 up about 9.3% through October. And what comes after has historically been even better. The market has posted positive returns in the six and 12 months following every midterm since 1950. Deutsche Bank adds that the fourth quarter of a midterm year has been positive in 21 of the last 23 cycles, with an average gain of 7%.
Not All Gridlock Is Created Equal
Wall Street likes to say that political gridlock is good for stocks. The data says it depends on who holds which branch.
Since 1950, the S&P 500 has averaged a 16.1% annual price gain when a Democratic president faced a Republican Congress, and 17.6% when a Democratic president faced a split Congress. The composition we’re about to get—a Republican president and Democratic Congress—has averaged just 4.8%, the lowest of the six combinations, according to Bloomberg data.
Before anyone runs for the exits, though, look closer. Much of the damage came in 1973 and 1974, during the Arab oil embargo and Watergate, and in 2008, during the global financial crisis. Congress didn’t cause those bear markets. The median year under this composition still gained 6.2%.
Year Three Has Been Positive Every Time
Timing matters as much as the lineup. 2027 will be the third year of President Trump’s second term, historically the strongest stretch of the presidential cycle. Since 1950, the market has risen in 17 of 19 third years, with an average gain of 17.3%.
Under this makeup, the record is perfect. From Eisenhower to George W. Bush in 2007, the S&P 500 rose in all seven third years, by an average of 16.1%.
Defensive Sectors Have Led
S&P 500 sector data goes back to 1989, giving us five years under this makeup: 1990 through 1992 and 2007 through 2008. Only two sectors averaged gains, consumer staples at 9.6% and healthcare at 5.4%. Both beat the market in four of the five years. Financials fared worst, with an average loss of 7.7%.
The market is already leaning that way. Health insurers and hospitals rallied Wednesday after Bernstein analysts said Democrats could delay parts of last year’s One Big Beautiful Bill Act that are expected to reduce Medicaid enrollment. Stifel notes that pushing back the 2027 start date for those cuts would be easier than restoring Obamacare subsidies. The exception may be pharmaceuticals, since drug prices are one area where the White House and congressional Democrats could find common ground.
Admittedly, five years is a small sample size, and both sectors have already had a strong 2026, with healthcare up about 21% and staples up about 18%. Investors may want to be selective rather than chase them.
The AI Backlash Starts at Home
One of the biggest surprises for me was the local ballot results. Data centers were the subject of 45 ballot measures in 10 states, and as of Wednesday morning, 33 measures to restrict them had passed, with six more projected to pass. In Ohio, home to 257 data centers, voters backed restrictions in all 20 local contests. Ohio, Texas and Georgia, three of the biggest hubs for data center construction, all elected Democratic governors. Texas Governor-elect Gina Hinojosa has called for a moratorium on new data centers.
I’m not counting AI out. Stifel expects little more than symbolic AI legislation from Congress over the next two years. But permits, power and tax breaks are largely decided by states and towns, and that’s where the backlash is.
Leadership in the market was already broadening. According to FactSet, the Magnificent Seven are on track for third-quarter earnings growth of 22.6%, compared with 32.6% for the other 493 companies in the S&P 500. If that holds, it would be the first time the group has trailed since late 2022. For investors heavily concentrated in mega-cap tech, this might be a good time to check your diversification.
Defense Is Far from Dead
Defense stocks sold off Wednesday morning, with Lockheed Martin down 6.5% and L3Harris down nearly 8%. The defense budget has grown from $900 billion fiscal 2024 to $1 trillion in fiscal 2026, and the White House wants $1.5 trillion for 2027. Deutsche Bank warns that defense has become more politicized since the start of the Iran war.
But Stifel expects the budget to keep growing regardless of who runs Congress, and it calls a selloff on fears of spending cuts a potential overreaction.
History agrees. In 2007, the first-year Democrats ran Congress under George W. Bush, the S&P 500 Aerospace & Defense Index climbed 30.2%, seven times the gain of the S&P 500. China deterrence, missile defense, munitions and drones have support on both sides of the aisle. I believe the pullback is an opportunity for stock pickers.
Stay Selective
Washington will continue to keep markets busy. Government funding runs out December 12, the debt ceiling becomes binding next year and President Trump retains broad authority over tariffs through executive actions.
History doesn’t promise gains under a Republican president and a Democratic Congress.
It does, however, reward discipline. Rebalance when markets swing, make sure you’re not overexposed to any single theme and keep a steady allocation to gold. As always, I recommend a 10% weighting in gold, with 5% in bullion and 5% in high-quality gold mining stocks.
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