Midterms Won't Settle Washington's Volatility

Political volatility should stay elevated even after Democrats retake the House this November, State Street Investment Management said. Republicans are still expected to hold the Senate, leaving little room for sweeping legislation.

Divided government looks likely, but historical midterm returns offer no reliable signal. Health care, utilities and financials could see targeted relief as volatility persists. AI regulation risk shifts toward statehouses even if Congress stays deadlocked.

Since 1949, equity returns in midterm years have averaged 4.6%, versus 11.3% in non-midterm years. State Street said that gap suggests investors may find more value in targeted sector shifts than in timing the election.

Elliot Hentov, chief macro policy strategist, and Arjun Kapur, sector research strategist, co-wrote the report. They said a divided Congress should extend current policy trends rather than upend them. The clearest effects could land in health care, utilities, financials and tech.

A divided government could ease pressure on Medicaid-focused managed care companies, the report said. In turn, certain Medicaid cuts from last year’s budget law are more likely to be delayed or softened. Steep cuts to National Institutes of Health funding also appear unlikely. Drug-pricing headlines are likely to persist, but State Street said congressional codification of most-favored-nation pricing appears unlikely, given Republican opposition to price controls.

The State Street Health Care Select Sector SPDR ETF (XLV) offers core exposure. The State Street Health Care Select Sector SPDR Premium Income ETF (XLVI) targets yield from that volatility.

Rising power demand from AI data centers and cloud computing is straining the grid, the report said. That is pushing electricity affordability, reliability and transmission investment into the policy debate. Permitting reform, grid modernization and nuclear power remain rare areas of bipartisan support. A Democratic House could block another round of subsidy cuts for renewables, State Street noted. Even so, wind and solar tax-credit restrictions enacted in 2025 are likely to remain in place.

Investors can track that tug-of-war over subsidies and tax credits through the State Street Utilities Select Sector SPDR ETF (XLU). Meanwhile, the State Street Utilities Select Sector SPDR Premium Income ETF (XLUI) collects income from that same volatility.

For financials, a divided Congress mostly means continuity, the report said. Regulatory decisions sit mostly with the Federal Reserve, the Federal Deposit Insurance Corporation and the Securities and Exchange Commission. Bipartisan measures like credit card rate caps remain conceivable but unlikely. That regulatory continuity shows up in the State Street Financial Select Sector SPDR ETF (XLF). Likewise, the State Street Financial Select Sector SPDR Premium Income ETF (XLFI) is built to collect on it.

AI remains a strategic priority for both parties, the report said, given its role in economic competitiveness and national security. But concerns over jobs, power use and local communities are likely to keep the technology in the political spotlight. Even full Democratic control of Congress wouldn’t be enough to curb AI data center construction federally, since such a move would face a presidential veto. Democratic gains could still add momentum to state-level restrictions, State Street noted. Both parties’ AI spending priorities flow into the State Street Technology Select Sector SPDR ETF (XLK). The State Street Communication Services Select Sector SPDR ETF (XLC) captures a similar slice of that buildout. Investors who want income from that state-level volatility have two options. The State Street Technology Select Sector...