MSCI flags rates, AI and oil as bigger portfolio risks than U.S. midterms

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MSCI flags portfolio risks

Highlights

MSCI noted US stocks historically average 12% gains post-midterms, but current near-record valuations differ from prior episodes of major rebounds.
Scenario analysis highlights four key risks: 10-year Treasury yields near 2002 highs, Fed tightening, AI spending slowdown, and Brent crude above USD 100/barrel.
MSCI found rising yields could simultaneously drive stocks and bonds lower in three of four scenarios, reducing multi-asset diversification benefits for investors.

Scenario tests highlight current market vulnerabilities

As reported by MSCI, U.S. stocks have risen in the six months after every midterm election since 1974, regardless of which party won, averaging a gain of 12%. The MSCI USA Index was roughly flat in the six months before those votes, compared with a 4% gain in the same period during non-midterm years.

MSCI said four of the five largest post-midterm gains came after declines of nearly 20% or more, a pattern that does not match the current market setup. Equities are instead trading near record highs, while several existing pressures are weighing on asset prices at the same time.

The firm identified four risks already in place, fiscal strain with the 10-year Treasury yield near its highest level since 2002, the Federal Reserve's inflation fight after its first rate hike since 2023, an AI investment cycle dependent on continued hyperscaler spending, and Brent crude trading above USD 100 a barrel. In its scenario work, MSCI examined two cases in which the 10-year Treasury yield rises, either through a higher term premium or tighter Fed policy, alongside an AI spending slowdown and an oil supply squeeze that lifts crude by 45%.

Multi-asset portfolios may lose historical protection

In three of the four scenarios, rising yields push stocks and bonds lower together, reducing the diversification benefit that multi-asset investors often rely on. Only the AI slowdown scenario offers some offset, because falling yields allow Treasurys to partly cushion equity losses.

The analysis points to a market environment in which the usual post-midterm rebound may be less reliable than in past decades. MSCI said scenario analysis can help multi-asset investors stress test exposures as the dollar and bond yields remain less predictable than the historical pattern for stocks.

In our earlier article on rising U.S. Treasury yields and widening fiscal strain, we explained how long-term borrowing costs above 5% are filtering through to higher mortgage rates, softer housing demand, and mounting federal interest expenses as deficits near $2 trillion. We also noted that heavy debt issuance, AI infrastructure funding needs, and political gridlock after the midterms could keep funding pressures elevated, limiting the odds of a near-term policy fix.

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