Bank of America's Hartnett: A "Democratic Midterm Sweep" Would Crash US Stocks and Puncture the AI Bubble

Original Author: Zhao Ying

Original Source: Wall Street CN

Michael Hartnett, Chief Investment Strategist at BofA Securities, warned that the surge in global bond yields to two-decade highs is becoming the biggest threat to the AI capital expenditure boom, and the upcoming U.S. midterm elections could serve as the trigger for market turmoil.

In his latest weekly Flow Show report, Hartnett pointed out that if the Democrats sweep both chambers of Congress in the midterms, U.S. stocks could face a decline of more than 10%, the dollar would weaken, bond yields would fall, and the AI bubble would face the risk of bursting. He characterized a "Democratic sweep" as one of the biggest tail risks currently facing the market, yet investors have barely priced this in at all.

Polymarket data shows that the probability of a Democratic sweep of both chambers has risen to 50%, far higher than the 10% probability of a Republican sweep. President Trump's approval rating is currently hovering in the 35%–40% range, significantly below the historical average of 53% in the two months preceding midterm elections. This political backdrop is reinforcing Hartnett's warning logic.

Bond Market Sounds the Alarm First

Hartnett believes the most noteworthy event of last week was not the stronger-than-expected jobs data, but rather the widespread breakdown across global bond markets.

The 10-year U.S. Treasury yield rose to 4.81%, approaching levels seen during the 2008 financial crisis; the 30-year U.S. Treasury yield climbed to 5.31%, its highest level since 2007. Meanwhile, Japan's 10-year government bond yield broke above 3.0% for the first time since 1996, and the 30-year JGB yield reached 4.2%, roughly four times the Bank of Japan's policy rate. In Europe, Germany's 10-year bund yield rose to 3.38%, a post-2011 high; the France-Germany yield spread widened to 88 basis points, and the Italy-Germany spread reached 84 basis points—both touching levels seen during the 2012 eurozone debt crisis. The Bloomberg Global Aggregate Bond Yield Index has risen to its highest level since 2007, just 1 percentage point shy of its highest level this century.

Hartnett distilled this phenomenon into a core thesis: "Bonds dominate the bubble." He argues that long-end yields—rather than equity narratives—are the true anchor for the current AI trade, and notes that until global 30-year yields fall below 5%, the builders and investors in AI infrastructure will continue to underperform the adopters of AI technology.

Midterm Elections: An Underestimated Market Variable

Hartnett acknowledged that the midterm elections are not a "regime change" election like Thatcher/Reagan in 1980 or Brexit/Trump in 2016, and will not fundamentally alter the upward trajectory of U.S. government spending. However, he emphasized that the structural differences in election outcomes will have a non-negligible impact on asset prices.

The BofA August Fund Manager Survey showed that 47% of respondents expect a "Republican Senate, Democratic House" outcome, 23% expect a Democratic sweep, and only 9% expect Republicans to retain control of both chambers. Currently, Republicans lead 53–47 in the Senate and 218–212 in the House.

On the Senate landscape, for Democrats to achieve a sweep, they would need to win at least four of the six vulnerable Republican-held seats—North Carolina (92% flip probability), Maine (69%), Alaska (64%), Ohio (55%), Texas (51%), and Iowa (37%)—while also defending their own vulnerable seats in Georgia (94%), New Hampshire (84%), and Michigan (65%). Hartnett singled out Ohio, Texas, Iowa, and Michigan as key battleground states that investors need to track closely.

Notably, Wall Street has turned its attention to the Texas gubernatorial race—the contest between Republican incumbent Governor Abbott (49% approval in polls) and Democratic challenger Hinojosa (45%)—which is viewed as an important barometer for the direction of AI data center expansion policy. Abbott was recently forced to announce a moratorium on data center construction to stem his declining poll numbers.

Market Impact Path of a Democratic Sweep

Hartnett provided a clear transmission logic for the market impact under a Democratic sweep scenario.

He argues that if the political landscape shifts from "populist capitalism" toward "populist socialism," it would mean taxes and regulation would turn from declining to rising, negatively impacting corporate earnings. At the same time, policy orientations such as suppressing inflation, improving healthcare access, and alleviating K-shaped wealth disparity would directly hit the AI capital expenditure boom and the "too big to fail" Wall Street ecosystem. Additionally, the erosion of Trump's political capital would weaken his ability to execute on priority issues such as AI, resource monopolies, and diplomatic pressure.

Synthesizing these judgments, Hartnett's asset allocation recommendations for a Democratic sweep scenario are: short financial stocks and the U.S. dollar as the optimal hedging tools; equities would fall more than 10%, the dollar would weaken, and bond yields would decline; international equities would outperform relatively, with Europe outperforming Asia.

Conversely, if Republicans unexpectedly retain both chambers, it would mean a broad recovery in risk appetite, a green light for the AI bubble, and a revival of the dollar "exceptionalism" narrative. The most likely scenario—"Republican Senate, Democratic House"—corresponds to moderate risk appetite—"gridlock is goldilocks."

Strategic Allocation: Long Commodities and Gold, Beware of Crowded AI Trades

Within the above macro framework, Hartnett maintains his cross-cycle core allocation recommendation: long commodities and gold as hedges against inflation and geopolitical risks. He noted that governments' "whatever it takes" fiscal interventions are suppressing long-end yields and supporting nominal GDP growth, and under this backdrop, the strategic logic that "any asset is better than bonds" still holds.

On the AI trade front, Hartnett's warning is more direct. He pointed out that the free cash flow of hyperscale cloud providers has turned negative under the pressure of capital expenditure commitments, and the AI bubble could "burst at any time." He proposed a post-bubble operational framework of "long humiliation, short arrogance," recommending a shift toward long-duration bonds and defensive sectors, including consumer staples, mining/raw materials, and healthcare, while avoiding crowded AI infrastructure-related plays.

From a long-cycle perspective, Hartnett also noted a contrarian signal: U.S. stocks have delivered a 15% rolling 10-year return over the past decade, commodities 11%, while U.S. bonds have returned -2%, the worst performance in nearly a century. Historical data shows that negative long-term bond returns often signal good buying opportunities for stocks (1939, 1974, 2009) and commodities (1933, 2018), providing historical support for his tactical bullishness on Q4 bonds.