By Michael Browne, global investment strategist at Franklin Templeton Institute
With the results now in, the scale of the Democrats’ victory is striking. Ron DeSantis, the outgoing Governor of Florida, described it as “close to an extinction-level event for Republicans”. In the UK, we witnessed something similar with the rout of the Conservative Party in 2024. The question now is whether the Democrats can make a better fist of governing than Keir Starmer has managed.
The cost of living dominates
The cost of living was the defining issue of the election, encompassing housing, healthcare, energy and everyday expenses. Much of the blame was laid firmly at the door of Donald Trump’s decision to attack Iran.
With riots continuing in France and spreading into Germany, the cost of living has also become the central political issue in Europe, where incumbent governments are increasingly bearing the brunt of public frustration. Inflation is seen as eroding living standards, while the weakening of the Trump presidency raises hopes of a settlement that could reopen the Strait of Hormuz.
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As one commentator observed, “The US may not want to pay for Europe’s defence, but Europe is paying for their war.”
This shift in political dynamics is likely to embolden both Iran and European governments in their dealings with Washington. For Europe, the question is increasingly whom to engage with in the US as the presidency enters its final two years. NATO is likely to become an even more important forum for defence cooperation, particularly given the absence of any resolution to the war in Ukraine and the continuing pressure to increase defence spending.
Europe is also particularly vulnerable to second-round inflationary effects. The ECB’s early decision to raise interest rates, followed by the Bank of England, illustrates the determination of central banks to prevent higher energy costs from becoming embedded in broader inflation. Policymakers appear prepared to tighten further, suggesting that inflation will remain a significant concern at least until the summer.
AI infrastructure: An increasingly political investment
AI infrastructure is becoming an increasingly political issue in the US. Data centres are contributing to concerns over electricity prices, water consumption and the cost of supporting infrastructure. Similar concerns exist in Europe, although there they are accompanied by a stronger regulatory dimension.
The election is unlikely to reverse the structural demand for AI. However, federal and state authorities may increasingly influence where facilities are built, how quickly projects proceed and who bears the cost of the necessary infrastructure.
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This could strengthen the case for locating more AI investment internationally, accelerating the regionalisation of computing capacity. European governments would likely welcome such a development, particularly given growing concerns about the security implications of excessive dependence on US technology. The restrictions surrounding Starlink’s use in Ukraine have only reinforced these anxieties.
Power generation, transmission infrastructure and electrical equipment should therefore remain important investment opportunities. Nevertheless, developers may face higher regulatory costs and longer approval processes. Interestingly, recent share-price performance suggests that investors may be welcoming some moderation in what has been a frenetic pace of development.
Greater sector dispersion
Political change could also increase dispersion between sectors.
Healthcare faces renewed scrutiny over drug pricing, insurance and reimbursement. Financial institutions may encounter tougher congressional oversight, while defence and energy companies remain sensitive to shifts in government spending, regulation and permitting.
These developments would reinforce trends already evident in Europe, where political intervention and regulatory pressures are increasingly influencing sector performance.
US political gridlock: Risk or opportunity?
Political gridlock need not be bad for markets. Indeed, the more interesting question may be whether gridlock constrains opportunity or helps unlock it.
Franklin Templeton Institute research covering the nine US midterm elections from 1990 through 2022 found that the S&P 500 Index gained an average of 14.5% over the subsequent 12 months, with positive returns following every election.
However, political gridlock should not be confused with a return to fiscal discipline. Large budget deficits and substantial Treasury issuance remain structural features of the US economy, making real interest rates particularly important for equity valuations, housing and infrastructure investment.
There is also a broader question of fiscal resilience. Should another event require a significant government response, how many countries retain the flexibility to act?
Europe’s fiscal position, with the notable exception of Germany, is arguably just as precarious, if not more so. The room for manoeuvre is limited, leaving governments increasingly exposed should circumstances demand further intervention.
A constrained presidency does not mean less uncertainty
A more constrained Trump presidency will not necessarily deliver greater policy certainty. Legislative gridlock could instead encourage greater reliance on executive authority in areas such as tariffs, trade, immigration, sanctions and foreign policy.
Tariffs have become an increasingly important source of US government revenue, making it difficult to envisage their wholesale removal, regardless of which party holds power.
Meanwhile, Europe has delivered a series of encouraging corporate earnings reports against a weakening economic backdrop, with higher interest rates adding to the pressure on activity.
The European political cycle begins with the Spanish elections at the end of November, followed by France in the spring and potentially the UK. Many of the same themes are likely to dominate these contests: inflation, declining purchasing power, fiscal constraints and growing dissatisfaction with incumbent governments.
The political direction is becoming clearer, even if the timing remains uncertain. Higher interest rates may slow the process, but they could also prolong the underlying economic and political pressures.
Ultimately, while political developments will continue to drive short-term volatility and sector dispersion, the longer-term investment outlook will depend on more fundamental forces: earnings growth, real interest rates and the sustainability of the AI investment cycle.
