Investment Outlook: US midterms, inflation and interest rates
US midterms
Tuesday’s midterms produced a decisive result. Democrats won control of both the Senate and the House of Representatives, flipping at least seven Senate seats, including Kansas, Iowa, Texas, Ohio, Maine, North Carolina and South Carolina.
A few races, including in Mississippi, are still being counted, but these will only affect the size of the majorities. From January, Democrats will be able to block parts of the President’s agenda, reject his nominees and investigate his administration.
Markets first took the result well. Stocks rallied on Wednesday after President Trump acknowledged the outcome, which reduced the risk of political uncertainty.
That changed last Thursday.
The sell-off was driven by fears that a Democratic Congress could regulate data centres more strictly, with some profit-taking likely adding to the move.
Investors had flagged this risk before the vote, since spending on data centres and other AI infrastructure is expected to exceed $1 trillion next year.
The likelier near-term outcome is more scrutiny rather than legislation that stops the build-out.
Even with a Democratic sweep, analysts doubt that a bill significantly impeding data centre expansion would become law, partly because some Democrats may be reluctant to undermine an industry important to economic growth and to competition with China.
We should therefore expect hearings, investigations and headlines, which may keep AI-related shares volatile.
Interest rates and inflation
The election comes as central banks are raising rates again, not cutting them.
Last week the Bank of England voted 8–1 to raise Bank Rate by 0.25 percentage points to 4%, with one member preferring a 0.5 point rise. This was its first increase since 2023.
The reason is energy: conflict in the Middle East has kept energy prices high and volatile, and the Bank expects inflation to reach about 5% by mid-2027, up from 3.5% currently.
In the US, the Federal Reserve left rates at 3.75–4% last week after raising them in September for the first time since July 2023, and markets now see a high probability of a further rise in December.
Higher rates make highly valued growth companies, including many AI names, more vulnerable to sharp falls when sentiment changes.
Our view
We see this as a sharp correction in a crowded part of the market, triggered by a political event, rather than a sign that the global economy is deteriorating.
AI-related shares had risen strongly, and many investors held similar positions. The election result gave them a reason to sell together, and the falls were fast and broad, especially in Asian markets dominated by chipmakers.
Europe and the UK have little direct AI exposure and have mainly been caught up in global selling.
That said, the backdrop is less supportive than it was earlier in the year.
Inflation is rising again because of energy prices, and central banks in the UK and US are tightening policy.
This is also why government bonds have not rallied as they usually do in a sell-off: with interest rates more likely to rise than fall, bonds offer less protection than usual.
We expect volatility to remain high while investors assess what the new Congress means for AI regulation and how far central banks need to go.
What this means for your portfolio
As mentioned in our communications through this year, diversification has been and will continue to be extremely important, especially should conditions remain volatile.
Our portfolios are not dependent on the US technology and AI trade alone; we hold an underweight position in US equities versus our strategic asset allocation model, while retaining meaningful exposure to the region.
Within actively managed portfolios, our thematic and style diversification includes value, quality and small-cap strategies alongside growth holdings; further reducing reliance on a single investment theme.
Although performance is still playing out, these diversifying positions have outperformed meaningfully so far this month.
Equally, where relevant to the portfolio such as Nova, absolute return and defensive multi-asset positions, such as Ruffer, Personal Assets and Capital Gearing, have provided a further layer of diversification alongside more esoteric long/short and risk premia strategies.
These holdings are intended to provide returns that are independent of traditional asset class moves and have helped cushion periods of market stress.
The precise mix varies by portfolio and risk level, and these positions cannot prevent losses, but they mean we are not relying on government bonds alone to provide protection.
Finally, gold has shown signs of life over the last 48 hours, rising by nearly 4% in £GBP terms.
If you would like to discuss the performance or make up of your portfolio please speak to your adviser, email us at info@brookswealth.co.uk or call the office on 01733 314553.