The artificial intelligence (AI) boom is becoming increasingly intertwined with the broader U.S. economy, fueling a surge in imports of semiconductors and servers while making data center construction an important source of business investment. That spending has supported growth but also widened the trade deficit, while a changing political landscape could bring greater scrutiny to the power demands, permitting, and costs associated with the buildout. None of that necessarily derails the AI investment cycle, but it could introduce more friction after a period of breakneck expansion. For investors, the shift is a reminder that enthusiasm over new technology ultimately runs into an old market reality: Capital spending can drive an investment boom, but productivity, profits, inflation, and interest rates will determine whether it delivers lasting returns.
Recent market volatility following the election results has understandably captured investors’ attention, but the underlying economic fundamentals remain an important anchor amid the political noise. In the third quarter, real GDP still grew at a 3.4% annualized rate, but a widening trade deficit subtracted roughly 3.3 percentage points from growth as imports soared. Now the political backdrop surrounding that investment boom is changing and was a catalyst for the recent selloff. Democrats have won control of both chambers of Congress, while Democratic gains in several states could bring greater scrutiny of the enormous power requirements, permitting rules, incentives, and costs associated with data center construction. In Texas, for example, Democrat Gina Hinojosa defeated Republican Governor Greg Abbott after a campaign in which data center expansion became a political issue. That does not mean the AI buildout is about to stop. But the political shift could introduce more friction into what until now has been an extraordinarily rapid investment cycle.
Midterm elections have historically acted as something of a clearing event for markets. In the weeks before Election Day, uncertainty about congressional control, taxes, regulation, and spending often encourages investors to hedge portfolios. Once the election passes, one source of uncertainty disappears. Investors can stop positioning around what might happen and begin adjusting to what happened. Historically, that transition has been favorable for equities. Since 1950, the S&P 500 has been higher 12 months after each of the last 19 midterm elections, producing an average gain of 15.1%. Even the weakest period finished higher: After the 1986 midterms, the index gained 1.1% over the subsequent 12 months despite the October 1987 crash occurring near the end of that window.
History is encouraging, but it shouldn't be mistaken for a forecast. Nineteen observations are a relatively small sample, and economic conditions, earnings, valuations, and monetary policy ultimately matter more than the calendar. And that brings us back to the more important point. Political opinions are best expressed at the polls, not in portfolios.
What happens in Washington matters. Elections can alter taxes, government spending, regulation, and the incentives facing businesses and households. But politics alone does not determine the direction of the economy or financial markets. More powerful forces usually do. Corporate earnings, consumer spending, inflation, interest rates, credit conditions, and monetary policy remain crucial to the economic and market outlook. Increasingly, that list also includes the secular AI investment cycle, which has become an important contributor to capital spending, trade flows, corporate profits, and market performance.
The more important question for markets is whether the massive amount of capital being deployed today translates into stronger productivity, earnings, and economic growth tomorrow. For now, investors have several fundamental supports to consider solid economic growth, resilient corporate profits, and the prospect that inflation pressures ease in the coming year. AI adoption could add another leg through productivity improvements, although investors will increasingly demand evidence that today's enormous capital expenditures can generate attractive returns. Washington can change the rules of the game, but economic fundamentals still determine the score.
As always, please contact us if you have any investment questions or concerns.
~ Mark and Elise
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All information is believed to be from reliable sources; however, LPL makes no representation as to its completeness or accuracy. This research material has been prepared by LPL Financial LLC. Tracking #1208637 (expires 11/2027).