Democrats won control of both chambers of Congress this week, setting up a very different policy environment for the final two years of President Trump’s term. Meanwhile, investors are confronting an unusual combination of strong earnings and falling valuations, while the massive AI investment boom is beginning to test the financial capacity of even the largest technology companies. Here are three developments we’re watching.
1. The Midterms Are Behind Us. Now What?
Democrats delivered a decisive victory in Tuesday’s midterm elections, flipping at least seven Senate seats and taking control of the House. While the magnitude was impressive, the direction wasn’t particularly surprising. Betting markets had placed the odds of a Democratic sweep near 80% heading into Election Day.
Historically, markets have tended to do well after the midterms. The S&P 500 hasn’t experienced a negative twelve-month return following a midterm election since 1938, with an average gain of approximately 15%. The historical results are even stronger when both chambers of Congress change hands, although the sample size is admittedly small.
But history only tells us so much. The more interesting question is what happens to policy in 2027.
For starters, the fiscal and monetary stimulus that supported economic growth in 2026 is expected to fade considerably next year. Additionally, divided government could complicate efforts to extend or expand the administration’s economic agenda. While political gridlock is often viewed favorably by markets, the historical evidence is less compelling under Republican presidents.
One area we’re watching particularly closely is the AI infrastructure boom. Democrats have expressed interest in rolling back the accelerated depreciation provisions that have helped fuel data center investment. With the debt ceiling approaching in early 2027, negotiations could provide an opportunity to push for changes. State governments are also increasingly scrutinizing the energy costs and infrastructure demands associated with data centers.
None of this means the AI build-out is about to stop. But it does introduce another variable into an investment cycle that has become increasingly important to both corporate earnings and economic growth.
Bottom Line: The historical post-midterm playbook is encouraging, but we wouldn’t rely on seasonality alone. The election removes one uncertainty while introducing new policy considerations. Ultimately, corporate earnings, economic growth, and the direction of interest rates will matter far more than which party controls Congress..
2. Stock Prices Are Rising While Valuations Are Falling
One of the market’s more remarkable developments over the past year has received relatively little attention. Despite the S&P 500 gaining nearly 11% over the previous twelve-month period, its forward price-to-earnings ratio has fallen from 23.2 to 18.8.
That represents one of the largest twelve-month valuation contractions in more than four decades. According to Ned Davis Research, there have been only six previous instances of a decline of at least four P/E points since 1983. In every one of those cases, stock prices were falling. This is the first time we’ve seen such a large contraction in valuations while the market actually advanced.
The explanation is earnings.
Corporate profits have grown at an extraordinary pace, particularly among companies benefiting from AI investment. Third-quarter earnings growth is currently tracking above 30%, with revenue growth also exceeding earlier expectations.
That’s the good news. The challenge is that investors are increasingly questioning whether this pace is sustainable.
Earnings growth appears to be approaching a peak, and the market is already discounting slower growth ahead. Consensus estimates still call for mid- to high-teens earnings growth in 2027 and 2028, a demanding hurdle by historical standards. Rising costs, higher interest rates, and potentially slower AI investment could make those expectations difficult to achieve.
Still, there’s a distinction between slowing earnings growth and declining earnings. The former can be perfectly consistent with a continued bull market. And with valuations considerably lower than a year ago, investors may have more room to absorb a moderation in growth.
Bottom Line: The market has become less expensive without requiring a significant decline in stock prices. That’s an encouraging development. But earnings have been doing the heavy lifting, and we expect the durability of that growth will be increasingly important as we move into 2027.
3. The AI Boom Is Becoming a Financing Story
For much of the past several years, investors have focused on the extraordinary demand for artificial intelligence and the enormous capital expenditures required to build the infrastructure supporting it.
Now a different question is emerging. Who is going to pay for all of it?
The largest technology companies have historically generated more than enough cash to finance their investments internally. But the scale of AI spending is beginning to challenge that dynamic.
According to Ned Davis Research, the major hyperscalers generated approximately $677 billion in operating cash flow over the past four quarters, compared with $869 billion in total investing outflows. In other words, operating cash flow covered only 78% of their investment spending.
However, operating cash flow still exceeded capital expenditures alone. But once other investments are included, these companies are increasingly relying on outside financing and balance sheet capacity.
Credit markets are beginning to pay attention. Yields on data center asset-backed securities have increased by more than a percentage point in recent weeks, while approximately $260 billion in planned data center projects have reportedly been canceled this year. Some cancellations reflect political and community opposition rather than financing constraints, but together these developments highlight the growing risks surrounding the build-out.
The broader economy remains resilient. Data center construction continues to grow rapidly, manufacturing activity is expanding, and the economic research we follow generally points toward slowing growth rather than an imminent recession.
But the concentration of business investment in AI infrastructure creates vulnerability. If higher borrowing costs, shareholder pressure, or disappointing returns cause hyperscalers to reduce spending, the implications could extend well beyond technology stocks.
Bottom Line: We remain constructive on the long-term opportunity surrounding AI. But the next phase of the investment cycle may be determined as much by financing conditions and returns on invested capital as by demand for the technology itself. That’s why we’re paying increasingly close attention to credit markets and the pace of capital spending.
Bringing It All Together
The common thread running through this week’s developments is that the economic expansion remains intact, but some of the forces supporting it are beginning to change. The midterm elections introduce a new policy backdrop, corporate earnings are still growing rapidly but face increasingly difficult comparisons, and the AI investment boom is becoming more sensitive to financing costs and investor expectations.
None of these developments necessarily signals the end of the bull market. In fact, falling valuations, improving market breadth, and continued economic growth provide reasons for optimism. But the next leg of the expansion may look different from the last. Rather than relying on a handful of technology companies and extraordinary earnings growth, a more durable advance may depend on broader participation across the economy and financial markets.
For investors, we think the message is to remain constructive, but disciplined. There are risks worth monitoring, particularly as we look toward 2027, but also opportunities as market leadership evolves. As always, staying diversified and focused on long-term objectives remains more important to us than trying to predict every twist in the economic or political landscape.
