Bank of Americas Hartnett: Democratic landslide in midterms will crash the U.S. stock market and burst the AI bubble.

Michael Hartnett, Chief Investment Strategist at Bank of America Securities, warned that the soaring global bond yields, reaching a 20-year high, are becoming the biggest threat to the hot trend of AI capital expenditure, while the upcoming U.S. midterm elections could serve as a catalyst for market upheaval. In the latest edition of the "Flow Show" weekly report, Hartnett pointed out that if the Democrats sweep both houses in the midterm elections, U.S. stocks could face declines of over 10%, the dollar would weaken, and bond yields would fall, putting the AI bubble at risk of bursting. He characterized a "Democratic sweep" as one of the largest tail risks in the current market, which investors are hardly pricing in at all. Data from Polymarket shows that the probability of a Democratic sweep has risen to 50%, significantly higher than the 10% chance of a Republican sweep. Former President Trump's approval rating currently hovers between 35% and 40%, significantly below the historical average of 53% two months before midterm elections, which reinforces Hartnett's warning logic. The bond market sounded the alarm first Hartnett believes that the most noteworthy event for the market last week was not the unexpectedly strong employment data but the complete breakdown of the global bond market. The yield on the 10-year U.S. Treasury rose to 4.81%, nearing the levels seen during the 2008 financial crisis; the yield on the 30-year Treasury reached 5.31%, the highest since 2007. Meanwhile, Japan's 10-year government bond yield surpassed 3.0% for the first time since 1996; the yield on 30-year Japanese bonds hit 4.2%, about four times the Bank of Japan's policy rate. In Europe, Germany's 10-year government bond yield rose to 3.38%, a new high since 2011; the spread between French and German bonds expanded to 88 basis points, while the spread between Italian and German bonds reached 84 basis points, both levels not seen since the Eurozone debt crisis in 2012. The Bloomberg Global Bond Yield Index has climbed to its highest level since 2007, just 1 percentage point shy of this century's peak. Hartnett distilled this phenomenon into a core judgment: "bond-dominated bubble." He believes that long-term yieldsnot stock narrativesare the true anchor of current AI trading and pointed out that until global 30-year yields fall below 5%, those building and investing in AI infrastructure will continue to lag behind those applying AI technology. Midterm elections: an underestimated market variable Hartnett admitted that the midterm elections are not "regime change" elections like the 1980 Thatcher/Reagan or the 2016 Brexit/Trump elections and will not fundamentally alter the upward trajectory of U.S. government spending. However, he emphasized that the structural differences in election results can have significant impacts on asset prices. Bank of Americas August fund manager survey revealed that 47% of respondents expect the outcome to be "Republicans control the Senate, Democrats control the House," while 23% anticipate a Democratic sweep, and only 9% expect Republicans to maintain control of both houses. Currently, Republicans hold a 53 to 47 lead in the Senate and a 218 to 212 lead in the House. Concerning Senate races, for the Democrats to achieve a sweep, they must secure at least four of the six vulnerable Republican seats in North Carolina (flipping probability 92%), 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 should closely monitor. Notably, Wall Street has turned its attention to the Texas gubernatorial electionbetween Republican incumbent Abbott (49% support in polls) and Democratic challenger Hinojosa (45%)as an important indicator of the direction of AI data center expansion policies. Abbott has recently been forced to announce a moratorium on data center construction to stem declining poll numbers. Market impact path of a Democratic sweep Hartnett provided a clear transmission logic regarding the market impacts in the scenario of a Democratic sweep. He believes that if the election pattern shifts from "populist capitalism" to "populist socialism," it would mean that taxation and regulation will transition from reduction to increase, negatively impacting corporate profits, while policies aimed at lowering inflation, improving healthcare access, and alleviating K-shaped wealth division would directly impact the AI capital expenditure boom and the "too big to fail" Wall Street ecosystem. Additionally, the erosion of Trumps political capital would weaken his execution capacity on priority issues such as AI, resource monopolies, and diplomatic pressure. In summary, Hartnetts asset allocation suggestion in the scenario of a Democratic sweep is to short financial stocks and the dollar as the optimal hedge; stock market declines will exceed 10%, the dollar will weaken, and bond yields will fall; international stocks will outperform, with Europe faring better than Asia. Conversely, if the Republicans unexpectedly hold both houses, it would indicate a rebound in overall risk appetite, with the AI bubble receiving a green light, and the dollars "exceptionalism" narrative reigniting. The most likely scenario of "Republicans controlling the Senate and Democrats controlling the House" corresponds to a moderate risk appetite"gridlock is the golden girl." Strategic allocation: Long commodities and gold, beware of crowded AI trades Within this macro framework, Hartnett maintains his core allocation recommendation across cycles: long commodities and gold as hedges against inflation and geopolitical risks. He pointed out that governments' "whatever it takes" fiscal interventions are suppressing long-term yields and supporting nominal GDP growth. In this context, the strategic logic of "any asset is better than bonds" remains valid. On the AI trading front, Hartnett's warnings are more direct. He noted that the free cash flow of ultra-large cloud computing providers has turned negative under pressure from capital expenditure commitments, indicating that the AI bubble "could burst at any moment." He proposed a post-bubble operational framework of "long the humiliated, short the arrogant," recommending a shift towards long-duration bonds and defensive sectors, including consumer staples, mining/materials, and healthcare, while avoiding crowded investments related to AI infrastructure. From a long-cycle perspective, Hartnett also noticed a contrarian signal: the rolling return rates of U.S. stocks over the past decade have been 15%, commodities 11%, while U.S. Treasuries have been -2%, marking the worst record in nearly a century. Historical data shows that a long-term negative return for bonds often signals favorable buying opportunities for stocks (1939, 1974, 2009) and commodities (1933, 2018), providing historical justification for his tactical bullish outlook on Q4 bonds. This article is sourced from Wall Street Insight, authored by Zhao Ying, edited by Wang Qiujia.