Author: tyonkee

Divided We Rise?

Since 1980, the S&P 500 Index has generally performed well in the weeks surrounding U.S. midterm elections. Specifically, the index has notched an average return of approximately 6.5% in the fourth quarter of midterm election years, compared with roughly 3.0% in the fourth quarter of all other years.

Why do stocks tend to perform well following midterm elections?

  • Markets often experience uncertainty ahead of elections, with a recovery sometimes beginning in the days leading up to Election Day. Once the outcome of the election becomes clearer, the range of potential policy outcomes narrows, reducing uncertainty and potentially supporting equity valuations. Historically, this pattern has occurred regardless of which party gains or loses control of Congress.
  • The incumbent president’s party has lost seats in 36 of the last 39 midterm elections. A divided government can limit the likelihood of sweeping policy changes, providing investors with greater visibility into the regulatory and fiscal environment. Major changes to corporate taxes, capital gains treatment, healthcare, financial regulation, and energy policy often require congressional support. Although a divided government can constrain both pro-growth measures and policies that may weigh on corporate profitability, markets may benefit from greater predictability and a narrower range of potential outcomes.
  • Administrations may pursue more difficult or politically contentious measures earlier in a presidential term, while placing greater emphasis on pro-growth policies and economic stimulus as the next presidential election approaches. This dynamic can contribute to a more supportive policy environment for equities later in the presidential cycle.

Does this suggest stocks will rally following next month’s midterm elections?
Historical evidence points to a favorable seasonal tendency for U.S. equities following midterm elections, particularly over the subsequent two to three months. However, this pattern should be viewed as a supportive factor rather than a standalone investment signal. A more compelling outlook would combine favorable election-related seasonality with improving earnings expectations, reasonable valuations, and supportive monetary policy. Of these four factors, at least two currently appear to be in place, providing a potentially constructive backdrop for U.S. equities, although historical patterns do not guarantee positive returns.

The Power Demand Supercycle

This week’s chart highlights the accelerating growth of electricity demand in the U.S., which has been driven primarily by the rapid expansion of data centers and increasing adoption of artificial intelligence. Specifically, U.S. power consumption is projected to rise from approximately 4.4 TWh in 2025 to 5.7 TWh by 2030, with data centers accounting for a significant portion of this increase. This trend is particularly evident in the PJM electricity market, where peak load is now forecast to reach 251 GW by 2046, significantly exceeding the 181 GW of current capacity. For context, the PJM Interconnection is the regional wholesale electricity market serving all or parts of 13 states and the District of Columbia, while peak load represents the highest level of electricity demand at a given time. The widening gap between projected peak demand and available capacity highlights the need for substantial investment in new generation, transmission, and storage infrastructure to maintain grid reliability and meet growing electricity needs.  Further, successive upward revisions to demand forecasts underscore the magnitude of anticipated electricity needs and the growing pressure on existing power infrastructure.

This widening gap between projected demand and available capacity is creating a substantial investment opportunity across the broader energy infrastructure ecosystem. Beyond data center development, significant capital will be required to expand power generation, modernize transmission and distribution networks, and deploy energy storage solutions to support grid reliability. For infrastructure investors, these trends present opportunities across both traditional and emerging sectors, including regulated utilities, contracted power generation, renewable energy, and battery storage. While the scale of investment needs is significant, execution risks related to permitting, grid interconnection, construction timelines, and regulatory frameworks remain important considerations. Core and core-plus infrastructure strategies may be particularly well positioned to benefit from this structural demand growth through long-duration assets supported by regulated or contracted cash flows.

Spooky Season

For investors, the spookiest thing about October might not be the ghosts and monsters that are bound to show up at front doors demanding candy, but rather a potential uptick in market volatility, which has remained relatively muted over the last several months. Indeed, the CBOE Volatility Index (“VIX”), which measures expectations for U.S. stock market volatility over the next 30 days based on S&P 500 Index option prices, currently sits at roughly 15.8, placing it close to the lowest third of observations since 1990. Additionally, the VIX has not climbed above 25 since April, suggesting that investors are not currently spooked about the near-term outlook for U.S. equities. It is worth noting, however, that October has historically seen the highest average VIX levels of any month since 1990. These dynamics can be observed in the chart above.

Often referred to as the market’s “fear gauge,” the VIX tends to rise when investors expect greater market uncertainty and fall when expected volatility is lower. A few factors may help explain why the VIX has tended to be higher in October. For instance, U.S. midterm and presidential election cycles can contribute to greater uncertainty during the fall, as investors assess potential changes to fiscal, regulatory, and trade policy that could result from a change in political leadership. To that point, CBOE has observed higher implied volatility around Election Day, including in 2024 as the presidential election approached. It is important to point out that October’s historical volatility has also been heavily influenced by major market events, particularly the Global Financial Crisis. Specifically, the VIX reached an intra-month high of roughly 89.5 on October 24, 2008, as the crisis intensified, and spent most of that month above 60. Additionally, although not captured in the chart above, the infamous “Black Monday” crash of 1987 that saw the S&P 500 Index plummet by more than 20% occurred on October 19. These data points suggest that at least part of October’s spooky reputation is attributable to exogenous market shocks rather than a predictable seasonal effect specific to the month itself.

While October has historically been associated with elevated volatility, market gyrations in the weeks ahead are by no means inevitable. Corporate fundamentals remain relatively strong, providing an important foundation for equity markets even as investors navigate a range of uncertainties. At the same time, the upcoming midterm elections and elevated market valuations could create greater sensitivity to economic developments, potentially contributing to periods of increased volatility. Ultimately, while October may have a reputation for spooking investors, the prospect of heightened volatility should not distract investors from their long-term strategic allocations or lead them to make short-term investment decisions based on seasonal market fears.

Getting Real on Inflation

The phrase “expectations of higher inflation” has become a staple in financial news to explain the increase in nominal U.S. Treasury rates this year (e.g., the yield on the 10-year U.S. Treasury security has surged over 80 basis points since the start of 2026). Indeed, the U.S. has seen an uptick in inflation over the last few months, with the Consumer Price Index (CPI) reaching 3.4% on a year-over-year basis in August (up from 2.4% in February but down from an intra-year high of 4.2% in May). Higher energy prices due to the conflict in Iran are a major driver of the increase in CPI, and earlier this month the Federal Reserve hiked its benchmark interest rate for the first time in over three years in response to these price pressures. Given these dynamics, some might reasonably assume that expectations of higher inflation are putting upward pressure on interest rates, but a closer look at the data reveals there may be other factors at play.

This week’s chart shows the nominal 10-year U.S. Treasury rate, the real yield on the 10-year U.S. security, and the “5-Year Forward 5-Year Breakeven Inflation Rate,” which represents expected inflation over the five-year period beginning five years from today. As the chart indicates, the breakeven inflation rate has remained largely range-bound in 2026, meaning nominal interest rates and real interest rates have risen in tandem.

Why has the breakeven rate not increased this year? Traditionally, higher inflation occurs when there is too much money chasing too few goods (i.e., “demand-pull” inflation). Supply disruptions that temporarily increase prices, on the other hand, can lead to what is known as “cost-push” inflation. Notably, disruptions in supply chains during the COVID-19 pandemic caused transitory inflation to become embedded since the money supply also increased dramatically during that period. It is important to point out, however, that despite the closure of the Strait of Hormuz, Federal Reserve policy has remained largely restrictive in 2026 and broader monetary conditions have not loosened significantly. Indeed, commodity shocks often lead to temporary increases in price levels, and this dynamic helps explain why long-term inflation expectations have not increased meaningfully since the beginning of the year.

In effect, rising real yields, rather than higher expected inflation, are driving nominal yields higher. Real yields are driven by economic growth and policy dynamics, and recent movements in real yields are primarily a result of stronger growth forecasts combined with a higher term premium due to concerns around fiscal sustainability and government borrowing. While inflation remains an important consideration for investors, the data suggest that the recent rise in nominal yields is being driven more by changes in the economic and fiscal outlook than by expectations of persistently higher inflation.

Let’s Make a Deal

For much of the past several years, the conventional view has been that higher interest rates and stretched valuations would keep buyers and sellers apart within private markets. While elevated base rates did indeed slow transaction activity as the market adjusted to a higher cost of capital, this dynamic did not lead to a structural freeze in dealmaking. To that point, average leveraged buyout, merger, acquisition, and recapitalization volume from the beginning of 2024 through the first half of this year was roughly $44.9 billion, only modestly below the $49.2 billion average exhibited from the third quarter of 2018 through the first quarter of 2022. These data points suggest that buyers and sellers are increasingly finding ways to bridge valuation gaps and transact within a higher cost of capital environment. It is important to note that dealmaking activity declined last quarter due to renewed uncertainty surrounding trade policy, geopolitical risks, and concerns regarding potential disruptions that artificial intelligence may cause within various industries. However, given that deal activity typically varies meaningfully from quarter to quarter, this decline could simply be a function of normal cyclicality rather than evidence of a coming slowdown.

For investors, the current environment presents both opportunities and risks. For instance, elevated base rates continue to support attractive gross yields for direct lenders, while higher debt-service burdens place greater pressure on borrowers and limit the ability of fund managers to financially engineer returns. As a result, underwriting discipline, downside protection, and operational value creation are likely to become increasingly important drivers of investment performance, particularly relative to the low-rate environment during which inexpensive leverage and multiple expansion played a more significant role in generating returns. Going forward, disciplined fund selection will be critical for investors, with manager performance dispersion potentially widening across both the private equity and private credit spaces.

No More Free Lunch?

There are many great things about working at Marquette Associates, but “Free Lunch Tuesday” is right at the top of the list for many employees. Each week, the company generously provides catered cuisine from one of Chicago’s many fine dining establishments, and team members gather in the cafeteria to enjoy great conversation, build connections across the firm, and eat a tasty meal free of charge! Of course, since Marquette is ultimately footing the bill, these lunches are technically not “free.” In fact, Nobel Prize-winning economist Harry Markowitz famously stated that “diversification is the only free lunch in investing,” meaning that risk-adjusted returns can be improved simply by combining different assets within a portfolio. For more than four decades, this maxim held true, as an investor could add equity exposure to a fixed income portfolio and increase overall returns while also reducing risk. Specifically, from 1976 through the end of 2019, the Bloomberg U.S. Aggregate Bond Index notched annualized return and standard deviation figures of 7.3% and 5.3%, respectively. Given the lack of correlation between stocks and bonds during that period, however, an investor could have created a portfolio with a 90% allocation to the Bloomberg U.S. Aggregate Bond Index and a 10% allocation to the S&P 500 Index to increase overall returns while decreasing risk. This diversification benefit (i.e., free lunch) can be observed on the left-hand side of the chart above.

Another Nobel laureate, Milton Friedman, famously argued that “there is no such thing as a free lunch,” emphasizing that every benefit comes with an associated opportunity cost. The last several years have certainly supported this notion, as the slope of the efficient frontier of stock-bond portfolio combinations has increased significantly since the start of 2020, and investors across the spectrum of combinations have been required to accept greater risk to achieve higher returns. Remarkably, the 100% S&P 500 Index portfolio exhibited the highest Sharpe ratio (0.69) of any of the combinations on the 2020–2026 efficient frontier, meaning that any amount of fixed income exposure led to lower risk-adjusted returns for investors over this period. This is in stark contrast to the 1976–2019 period, during which the 100% S&P 500 Index had the lowest Sharpe ratio of any possible combination on the efficient frontier (0.51), with the highest being a combination closer to 50% S&P 500 Index and 50% Bloomberg U.S. Aggregate Bond Index (0.65).

The primary driver of the dynamics detailed above has been the breakdown in the traditional relationship between stocks and bonds. Historically, bonds exhibited low or even negative correlation with equities, providing meaningful diversification benefits within multi-asset portfolios. For instance, during periods of economic expansion in previous decades, stronger growth and rising interest rates often weighed on bond prices while supporting corporate earnings and stock valuations. Conversely, during periods of economic stress, declining interest rates generally boosted bond prices while causing equities to come under pressure. Indeed, from 1976 through 2019, the Bloomberg U.S. Aggregate Bond Index exhibited a correlation of 0.20 with the S&P 500 Index. This relationship, however, has changed materially since the start of 2020. That year, the Federal Reserve responded to the economic shock caused by the COVID-19 pandemic with aggressive monetary easing, driving interest rates sharply lower and supporting strong returns across both fixed income and equity markets. The Bloomberg U.S. Aggregate Bond and S&P 500 indices returned 7.5% and 18.4%, respectively, in 2020. In 2022, circumstances shifted sharply, as high inflation, tighter financial conditions, and concerns around corporate profitability proved challenging for most asset classes, and the Bloomberg U.S. Aggregate Bond and S&P 500 indices returned -13.0% and -18.1%, respectively. One notable factor contributing to the higher correlation between stocks and bonds in recent periods has been the increasing concentration of growth-oriented companies within equity indices. Because these businesses derive a significant portion of their value from cash flows expected far in the future, their valuations are particularly sensitive to interest rate fluctuations. As a result, rates have played a more prominent role in determining both fixed income and equity returns over the last few years, increasing the likelihood that the two asset classes move in the same direction. To that point, the correlation between the Bloomberg U.S. Aggregate Bond Index and the S&P 500 Index has been 0.51 since the start of 2020.

While the benefits of a traditional stock-bond portfolio may now be less pronounced than they have been historically, diversification remains a valuable portfolio construction tool because equities and fixed income are still not perfectly correlated. Even if the two asset classes move in the same direction over the coming quarters, the higher bond yields offered today provide a meaningful source of income and return that was largely absent during the low-rate environment of the early 2020s. Additionally, as inflation continues to moderate and monetary policy normalizes, the historical relationship between stocks and bonds is likely to reassert itself, which may restore some of the diversification benefits investors have come to expect from multi-asset portfolios. Although the diversification benefits of a traditional stock-bond portfolio have diminished in recent years, maintaining exposure to multiple sources of return remains a cornerstone of prudent long-term investing. And for all of us at Marquette Associates, let’s hope the phrase “no more free lunch” never extends beyond portfolio theory and into the lunchroom!