A divided government would cause the S&P 500 to rise 11% over the near term

By Jonathan Garber FOXBusiness

The fiery but ultimately inconclusive debate between President Trump and Democratic challenger Joe Biden on Tuesday may leave more questions than answers for investors as the tumultuous 2020 election moves into its home stretch.

With Biden leading Trump nationally and control of the Senate in flux, one outcome may be a divided government that prevents major change by either party, giving investors more of the stability they crave.

“A divided government scenario would lead to a smaller change in interest rates and a reduction in political uncertainty,” wrote a team led by David Kostin, chief equity strategist at Goldman Sachs.

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They say such an outcome would be the best-case for the S&P 500, causing the index to rise 11% to 3,700 over the near term and to 4,000 by mid-2021.

As investors position themselves for the different possible outcomes, they have to weigh a dramatic tightening of the polls over the last two months.

Former Vice President Biden leads Trump by 6.1 points nationally, according to an average of polls compiled by RealClearPolitics. He held a 9.3-point lead at the beginning of July. Additionally, Biden’s lead in key battleground states has narrowed from 6.2 points to 3.5 points.

Making things even more complicated for investors is the tight race for control of the Senate while Democrats are expected to keep the House.

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A Democratic sweep, meanwhile, could have a “modestly positive net impact” on S&P 500 companies’ profits, according to Goldman, but that would depend on the size and shape of tax reform and fiscal stimulus for an economy damaged by the COVID-19 pandemic.

A so-called blue wave might result in the S&P 500 climbing 1.93% to 3,400 in the short term and to 3,800 over the medium term, the strategists said.

Regardless of the election outcome, Goldman believes stocks are headed higher.

Over the near term, the removal of election uncertainty should help reduce equity risk premium while supporting valuations, boosting the S&P 500 to 3,600, an average of the two weighted election probabilities. Equity risk premium is the higher return that investors typically get on stocks compared with securities such as U.S. Treasurys that are widely viewed as carrying little risk of losing money.

Looking ahead, Goldman sees the S&P 500 reaching 3,800 by the middle of next year.

“The status of a vaccine, the path of the economic recovery, and Fed policy will be more important in determining equity valuations than the outcome of the election,” Goldman wrote.

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