Stock market action after 2020 election sweep might surprise you

The outcome of the 2020 election will have major implications for the stock market, but not in the way you may think.

If either Republicans or Democrats win total control of White House, Senate and House of Representatives, for instance, that can limit gridlock in Washington and allow the government to accomplish more -- but it's not necessarily good for traders.

The stock market generally performs better under a divided government, according to the investment bank Goldman Sachs.

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Stock-market returns during periods of a divided federal government have “typically exceeded returns achieved when one political party controls the White House, Senate, and House of Representatives,” David Kostin, chief U.S. equity strategist at Goldman Sachs, wrote in his 2020 outlook.

Since 1928, the S&P 500 has averaged a 12-month return of 11 percent when the election resulted in a divided government and 8 percent when a unified government was voted in. The returns of both were up one percentage point excluding recessions.

At the time of Goldman’s report, PredictIt, which forecasts market and political events, assigned a 74 percent probability to Democrats retaining control of the House in 2020, a 54 percent chance to the party winning the White House and just a 35 percent to its capturing the Senate.

Kostin expects the S&P 500 will climb more than 8 percent from current levels to 3,400 by the end of next year, but says that a unified government could lead the benchmark index to fall almost 17 percent to 2,600.

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While Goldman cites several risks to its forecast, including rising corporate leverage, reduced company buybacks, and low CEO confidence, the firm said political uncertainty and trade tension with China “remains the most salient risk to the path of U.S. equities in 2020.”

The S&P 500 has gained nearly 25 percent in 2019 despite trade war uncertainty. The strong gains have led some of the biggest names on Wall Street to at least think twice about the gains continuing in 2020.

Bridgewater Associates, the world’s largest hedge fund with $160 billion in assets under management, recently purchased $1.5 billion worth of puts on the S&P 500 and Europe’s Stoxx 50 to protect against the possibility markets will take a tumble by March.

Ray Dalio, co-chief investment officer and co-chairman of Bridgewater, stressed the position is not due to a bearish stock market view, but was instead made to hedge its positions. He tweeted in protest after a Wall Street Journal article suggested otherwise.

Morgan Stanley strategist Michael Wilson says the Fed expanding its balance sheet at a pace of $60 billion a month could send the S&P 500 over the upper end of his 3,250 bull-market projection in early 2020, but says the rally will run out of steam by April as the “liquidity tailwind” fades. He has a 2020 year-end target of 3,000 or about 4 percent below current levels.

If history is any indication, 2020 is likely to be another up year for the stock market. Dating back to 1928, the S&P 500 has only had four losing presidential election years on a total return basis, according to data compiled by the Wells Fargo Institute.

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“The bull market in U.S. equities will celebrate its 11th anniversary in 2020,” Kostin wrote. “A durable profit cycle and continued economic expansion will lift the S&P 500 index by 5 percent to 3,250 in early 2020. However, rising political and policy uncertainty will keep the index range-bound for most of next year.”