BofA's Hartnett: Stocks Face 10%+ Drop if Democrats Take Senate

Bank of America strategist Michael Hartnett warns that U.S. equities could see a correction of over 10% if Democrats secure control of the Senate in the upcoming November midterm elections. This outlook challenges the market’s current optimistic pricing of election outcomes.

Analyst’s Outlook on Midterms

Hartnett believes the market is overly optimistic, pricing in moderate midterm election results and a continuation of deregulation and AI-friendly policies. He suggests this assumption may be incorrect.

A strong Republican performance could lead to a stock surge, but a Democratic sweep of the Senate, particularly if combined with a win in the Texas Governor’s race, could trigger a significant market decline.

Policy Implications for Markets

Should Democrats gain the Senate, two core market narratives could be impacted: financial deregulation and political support for AI capital expenditure.

The Texas Governor’s race is highlighted as a key wildcard, acting as a referendum on AI infrastructure policy. A shift in this outcome could pressure assumptions supporting deregulation trades and AI capital expenditure.

Market Positioning and Flows

Current market positioning is described as “extreme bull,” with the BofA Bull & Bear Indicator deep in “sell” territory. This suggests a crowded upside trade that could amplify volatility if election results surprise.

Recent fund flow data shows shifts, including approximately $6 billion in cumulative outflows from semiconductor funds over three weeks. This indicates a potential move towards a more bearish scenario, though not necessarily a direct midterm hedge.

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Options Market and Stocks to Watch

Traders should watch several sectors closely for potential volatility around the midterm elections.

• SPY and QQQ: The broader market indices are at risk of a 10%+ correction if Hartnett’s scenario plays out. Watch for increased put activity.
• NVDA and SMH: Semiconductor and AI-related stocks could face headwinds if political support for AI capital expenditure wanes. Outflows from semiconductor funds are already noted.
• JPM, BAC, and other financials: These could be impacted by changes in financial deregulation policies under a Democratic Senate.

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