Midterm elections and geopolitical risk will drive the market

Raymond James Washington Policy Analyst Ed Mills examines how midterm elections and geopolitical risk are shaping the market landscape

As we move through 2026, the political and geopolitical landscapes remain key drivers of policy uncertainty. For the midterm elections, our base case is a Democratic House and Republican Senate, a historically favorable outcome for equities. Meanwhile, the US-China relationship has stabilized modestly, and multiple Trump-Xi meetings are expected this year, creating opportunities for incremental progress, with key questions around export controls and access to advanced technology unresolved. Geopolitical risks remain elevated, particularly amid the ongoing US-Iran tensions. While markets have remained resilient to geopolitical flareups so far, a prolonged conflict or sustained pressure on energy prices could weigh on economic activity and introduce greater market volatility.

Base case for the 2026 midterm elections

Our base case remains a Democratic House and Republican Senate. Divided government historically has provided for a market-friendly backdrop, limiting legislative surprises, but President Donald Trump’s use of executive action could continue to drive uncertainty and volatility. As we have framed all year, elections ultimately remain a math problem.

Republicans enter the cycle with a 220-215 House majority. Holding a majority would require 218 seats, and several structural challenges against Republicans present an opportunity for Democrats to capture a majority – including an unfavorable national environment, weak presidential approval ratings, elevated voter dissatisfaction and an energized Democratic base. Redistricting efforts could add anywhere from four to eight seats to the Republican column and reduce Democratic gains. In the Senate, Democrats would need to net four seats out of the 33 Senate races. Midterm Senate election results tend to match the presidential results in most states.

An analysis of previous midterms shows there is a 20%-29% deviation between the winner of the Senate election and the state’s preference in the previous presidential election. For Democrats to win the Senate, they would need a 67% deviation. Not impossible, but a significant departure from recent midterm election results.

The impact of divided government on policy

Traditionally, policymaking is limited to bipartisan efforts in divided governments. Volatility occurs on must-pass legislation such as government funding bills, increasing the risk of government shutdowns. A key issue after the election will be how Democrats and Trump approach policy debates. Will Democrats and Trump work together or will they seek to define the other as the obstacle? In his second term, Trump has increasingly used executive action and emergency powers to implement policy. The unpredictable nature of these efforts – for example, the April 2025 tariff announcement – has caused significant market volatility. Markets have become more accustomed to this style and the courts have limited some of these actions, but it may usher in a different policy environment than previous divided government scenarios.

The impact of divided government on the market

Historically, equities perform best under this scenario, and markets experience the least overall volatility. While shutdown risks would likely increase, other policy initiatives would face substantial hurdles. Areas with bipartisan support, including potentially more hawkishness toward China, infrastructure spending, national security initiatives, supply chain resiliency and permitting reform remain the most likely avenues for legislative action.

Sweep scenarios and market impact

While a divided House and Senate remain our base case, investors should not ignore the possibility of sweep scenarios. Unified control of Congress by either party would increase the likelihood of increased standoffs between Congress and the president. A change in the Senate majority would limit the president’s ability to win confirmation of his appointments and would likely cause the return of many of the fired Democrats at independent agencies. Increased executive action, as discussed above, would also become even more likely.

US-China

The US-China relationship is currently characterized by a mutual desire to reduce friction and increase stability. While fundamental tensions remain – and with that, a long-term effort to mutually de-risk – both Trump and Xi are placing emphasis on the truce struck last October. In their first meeting of 2026, this focus was demonstrated by the announcement of aerospace and agricultural purchase agreements, initial progress on the bilateral Boards of Trade and Investment, and a stated desire to continue high-level contact between the two countries. Taiwan remains one area of tension, with Xi seeking concessions from Trump on arms sales to the island and Trump potentially using their suspension as a bargaining chip.

Expectations for US-China ties this year

Trump and Xi have already met once this year in Beijing and up to three more meetings are expected, the next being a September summit held in Washington, DC. Given the multiple expected meetings, few of the market-relevant deliverables were raised or finalized at the May meeting. As such, key issues such as tech controls will be watched closely in the run-up to the September meeting.

The Trump administration has overall shown a greater willingness to export leading-edge US tech to China than its predecessor or Congress, and Beijing is keen to receive access to the latest semiconductors and semiconductor capital equipment. While some initial easing has taken place, it remains to be seen whether Trump opens the spigot further given competing concerns between the US tech industry, which wants to promote the US tech stack overseas, and concerned China hawks in Congress. Further progress on the Board of Trade is another key issue, with the White House preparing to receive public comment on which goods should be eligible for a $30 billion trade initiative intended to identify and promote bilateral trade in sectors not sensitive to national security.

Key lessons for investors with geopolitics front and center in 2026

One fundamental shift we have observed between 2025 and 2026 has been the White House’s preferred policy lever for securing policy outcomes overseas. While 2025 was dominated by the use of economic tools like tariffs, paired with fairly limited uses of force, 2026 has been marked by the demonstrated willingness to use military force in a more expansive manner. This shift, exemplified most by the US-Iran war, has been accompanied by a renewed focus on the Western Hemisphere and the adoption of a wartime footing on the defense spending and industrial policy front.

Key risks for investors to expect going forward

While a durable resolution to the Iran war remains a ways away (especially as negotiations continue between the US and Iran), other geopolitical risk areas are simmering, such as Cuba, Greenland and Venezuela. If these regions are to see flareups, market expectations will likely continue to assume a short-term duration to these engagements. However, the more these incidents take place, and the longer US-Iran negotiations take to complete, the more these expectations will be challenged. Market reaction to the geopolitical flareups of recent memory has overall been relatively muted; economic stimulus and earnings optimism have played roles here, but the longer pressures continue – such as oil pressure associated with the Iran war – the greater the economic impact and associated market risk. 

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