AI policy concerns cast a shadow over stock and bond markets as the U.S. midterm elections enter the final countdown.

Wall Street expects Democrats to win control of at least one chamber of Congress in Tuesday's U.S. midterm elections, setting the stage for potential sharp swings in stocks and bonds. AI regulation, defense spending and crypto legislation will all be on the table. A basket of Republican-linked stocks tracked by UBS has tumbled sharply since peaking in August, badly underperforming the S&P 500. One major area where the impact could show up is the AI trade that has driven the stock market over the past few yearsDemocrats are expected to push for stricter regulation and oversight of the technology. Meanwhile, local governments are facing pressure to block data center construction in their communities. Robert Waldner, chief investment officer at Invesco Advisers, said that if the election's "big political signal" is that "data centers are bad, that would have an impact on growth." Meanwhile, other sectors could also be targeted. Defense contractors could come under pressure if Democrats push to curb defense spending. Large banks that have raked in profits from the trading boom could face scrutiny. And crypto-related companies could draw congressional attention simply because the industry is closely tied to the Trump family. All of this is prompting some Wall Street professionals to position for equity selling pressure and rotate into safer government bonds. In addition, many traders appear overly locked into existing positions and expectations of a split Congress, leaving them vulnerable to sharp volatility. "Investors going into the election are long the dollar and short duration, with little protection against volatility, especially in equities," said Karl Schamotta, strategist at Corpay. "The consensus expectation that a narrow Democratic win will produce congressional gridlock, allowing the president to advance his goals through executive action, but there are significant tail risks." With just days to go before voting day, here are the markets and stock sectors worth watching. U.S. Treasuries History shows that congressional gridlock is good for bonds because it blocks aggressive policies that would expand the deficit and push up long-term Treasury yields. But this time, bond market watchers say any fiscal relief will be limited and unlikely to produce a sustained rally, because the deficit is about 6% of the economya level rarely seen outside recessions. "We simply have too much debt, and one day we'll have to face it. But if over the next two years gridlock means we don't keep adding debt at the pace we have been, I think that's a good thing," said Oliver Chambers, head of fixed income SMA at Clark Capital Management. If Democrats perform particularly strongly, investors may see it as a signal that the American public supports AI regulation, which would weigh on tech stocks and weaken growth expectationsin which case Treasury yields could move lower. Dollar Like Treasuries, the dollar could also get a boost from a Democratic win, for the same reason: the stabilizing effect of a divided Congress. Some investors believe a divided government could push U.S. President Trump to lean on policies he can advance unilaterally through executive power. Any escalation with Iran that Trump has hinted could come after the election is expected to continue supporting the dollar by pushing up energy prices and prompting the Fed to raise rates. New tariffs could also support the dollar by stoking inflationunless they trigger the global "sell America" trade that became popular last year. Tech and AI Infrastructure Regardless of the midterm outcome, Trump will remain president and could veto any legislation deemed unfavorable to the tech industry. That could limit risks for Nvidia and big AI spenders such as Alphabet, Meta Platforms and Microsoft. Still, strategists are preparing for a stronger-than-expected Democratic showing to hurt sentiment around the AI trade. "The key to the midterms isn't the risk of federal policy immediately restricting data centers, but rather laying the groundwork for legislation that could come in 2029," said Arianna Salvatore, head of U.S. public policy research at Morgan Stanley. Morgan Stanley analysts said data center REITs and emerging cloud service companies are vulnerable to proposed compute taxes. On the other hand, off-grid power providers such as Bloom Energy, Cummins and GE Vernova could get a boost from stricter policies. Healthcare Hospitals could benefit if Democrats succeed in reversing the Medicaid cuts included in last year's tax bill, said Tobin Marcus, head of U.S. policy and politics at Wolfe Research. He said Democrats, if seeking concessions in a possible debt ceiling negotiation, could push for wins in healthcare. Jefferies analysts said hospital stocks such as Acadia Healthcare, HCA Healthcare and Tenet Healthcare have near-term election-related upside. Insurers Centene and Oscar Health could also see buying on hopes that Democrats will negotiate to restore enhanced Affordable Care Act subsidies that expired at the end of last year, though the firm sees that outcome as unlikely. Defense Defense contractor stocks have underperformed this year on concerns that a big Democratic win could lead to stricter oversight and funding delays. Drone stocks such as AeroVironment and Kratos Defense & Security Solutions have fallen the most. If Democrats control one or both chambers, funding critical to the Pentagon's ambitious drone production plans could be at risk. However, JPMorgan believes military spending could rise if Republicans hold their ground, naming L3Harris, Lockheed Martin and Northrop Grumman as potential beneficiaries. Financials and Crypto JPMorgan believes Republicans favor lighter regulation of the financial industry, so an unexpected Republican landslide would benefit lenders such as Bank of America, Citigroup and Wells Fargo. But Barclays analyst Jason Goldberg said the election is unlikely to change issues such as bank stress tests, because the heads of the Fed, FDIC and OCC may remain in place for several more years. In crypto, the odds of industry-friendly legislation could fall if Democrats control Congress. Democrats, along with a handful of Republicans, blocked the Clarity Act in September, sending stocks such as Coinbase and Circle Internet Group sharply lower. Potential Investigation Targets Wall Street is bracing for a wave of Democratic investigations. Evercore ISI said AI-focused hearings could create market risk, with companies such as Nvidia and Amazon already receiving Democratic inquiry letters. Evercore also expects Democrats to launch investigations into sectors tied to affordability issues, including energy, healthcare, food production and agriculture. Companies that received U.S. government equity stakes, such as Intel, IBM and rare earth producer MP Materials, could also face inquiries, putting their share prices at risk. The Musk Empire A Democratic win of one or both chambers could affect Tesla and SpaceX, owned by Republican mega-donor Elon Musk, as investors anticipate a possible merger of the two companies. Vikram Rai of First New York said that while Congress alone cannot kill a deal, an empowered Democratic Party would be able to slow it down. "If there's a blue wave, both stocks face significant headline risk," he said.