The US stock market, particularly the options market, is currently exhibiting a mix of fearlessness and fragility just two months before the midterm elections. The Cboe Volatility Index (VIX) remains around 15, which is below its long-term median of 17.6, indicating little anxiety among investors regarding the upcoming elections. However, a UBS strategist noted the market has been "extremely fragile," and an Evercore ISI strategist described the overall implied volatility as "compellingly cheap," suggesting an underlying vulnerability to unexpected shocks.
Prediction markets are heavily favoring a divided government after the midterms. Polymarket traders forecast a 51% chance of a Democratic sweep on Election Night, with another 36% expecting Democrats to take the House while Republicans retain the Senate. Only one-eighth of bettors believe Republicans will maintain their unified government. Similarly, on Kalshi, the 2026 House control market saw a massive surge in trading volume on September 9, reaching $684,315, nearly 10 times its weekly average. Despite this surge, Democratic odds to flip the House remained steady at 85%, indicating a strong consensus among traders.
Historically, a split Congress under a Republican president has been associated with more modest stock returns. Between 1926 and 2023, periods with a Republican president and a divided government yielded an average annual return of 7.33% for the S&P 500, compared to 14.52% when Republicans held a unified government. However, a split Congress is not necessarily seen as a negative, as it can make passing major tax and spending legislation more difficult. From 1946 to 2020, the Dow Jones Industrial Average averaged a 12.9% annual return with a split Congress.
Political developments are also influencing market sentiment. Speaker of the House Mike Johnson is actively campaigning to protect the Republican majority, particularly in battleground states like Texas, where a new congressional map makes it a key area. Additionally, a $3 million offensive by J Street PAC targeting five races involving AIPAC-backed Republicans, including Georgia Senate candidate Mike Collins and four House incumbents, has garnered attention from prediction market traders, contributing to the high trading volumes on platforms like Kalshi.
