Many investors are worried about what the election could mean for stocks, and understandably so. After all, the surprise election of Donald Trump, and the deregulatory regime and corporate tax cuts that came with it, kicked off an epic rally for stocks.

In fact, after Trump won, the S&P 500 went on a 14-month winning streak, with the largest decline from record highs just 2.7%. That was the longest period without a 5+% pullback in US market history. Well, Goldman Sachs, one of the blue-chip economist firms (16 most accurate out of 45 tracked by MarketWatch), and one of the world’s most respected asset managers, just put out a new research note predicting that stocks will indeed sell-off if Biden wins, and institutes new higher regulatory and corporate tax regime. Here are the three most important things you need to know ahead of the election to protect your hard-earned savings and avoid potentially costly and even retirement dream killing mistakes.

Biden’s Victory Is Now Looking Very Likely

Every few hours the 538 model takes in the most recent polls and runs 40,000 simulated elections, using the most advanced statistical model available among any political forecasters.

Currently, 538 gives Biden an 88% probability of winning the White House, and if the polls remain stable at current levels through election day, Nate Silver, the head of 538 estimates that probability will climb to 95%. Of course, even if Biden wins, that doesn’t mean he’ll be able to accomplish any or even most of his proposals. Who controls Congress will actually determine what kind of increased regulations and taxes might be coming.

Democrats Look Well Positioned to Gain Control of Congress

The Democratic-controlled House was never expected to be up for grabs in this election, and currently, 538 estimates a 95% probability Nancy Pelosi will remain speaker. It appears that Democrats are most likely to end up with 238 House seats, up six from their current 232. What matters most is the Senate, where whoever controls the chamber by even one vote decides what bills get brought up for votes and which languish in obscurity and die on the vine.

Currently, 538 estimates a 74% chance the Democrats will gain control of that Chamber, picking up between four and five net seats for a total of 51 to 52. But what does all this mean for stocks? That’s where Goldman’s most recent note comes in, which has very important implications for your portfolio.

Why Goldman Thinks Stocks Are Likely to Sell Off…And How You Can Protect Your Portfolio

Biden’s planned capital-gains tax hike may put immediate selling pressure on stocks given what’s happened in markets after the previous rate increases, according to Goldman Sachs.A team of Goldman analysts led by Arjun Menon wrote on Friday that Joe Biden’s proposed changes to the corporate tax code would be complemented by an increase in the tax rate applied to capital gains and dividends for the highest-income individuals.

History has shown that capital-gains tax hikes spark stock sell-offs. After the last capital-gains tax rate increase in 2013, the wealthiest 1% of households sold 1% of their starting equity and mutual fund assets, worth about $100 billion today, in the three months leading up to the rate hike, according to Goldman. As of 2020, the wealthiest 1% of Americans own 53% of all household stocks. Their collective actions can move markets.” – Business Insider (emphasis added)

That sounds pretty scary, right? Actually, it’s not. While this selling may be a downside risk to stock allocations in 2020, Goldman said it will not result in a long-term sell-off or slowing economic growth. In the months following the 2013 rate hike, the top 1% bought back more stocks than they had sold prior to the change, said Goldman. Their reduction in stock exposure was only temporary, and Goldman said it believes that the same pattern is likely to occur again.

“We expect household selling around capital-gains tax rate changes should be short-lived and fully offset in the subsequent quarters,” Goldman wrote.” – Business Insider (emphasis added). Let’s say that Goldman is right and the richest 1% of Americans, who collectively own 53% of stocks, sell 1% of their holdings. That equates to 0.5% of the entire market being sold. While true that stock prices are set at the margins, which could amplify short-term declines, Goldman, UBS, JPMorgan, and Moody’s are all advising their clients to “buy the dip” that may occur leading up to election day.

(Source: JPMorgan Asset Management)

JPMorgan’s economists estimate that depending on who wins on election day US stocks could swing up or down about 4%. More volatile companies could swing up to 6% while lower volatility ones like Johnson & Johnson might move just 2%. What if these analysts are wrong and we have a contested election with no clear outcome for several weeks such as occurred in 2000? The stock market fell 8% during that contested election.

(Source: Guggenheim Partners, Ned Davis Research)

Since 1945 and 2009 we’ve averaged a 5+% pullback every six months. The average market pullback has been a 7% decline that saw stocks hit record highs just one month later. The average correction has been a 14% decline that took eight months for the market to recover from, measured from the market high to a new record high.

Since 1980, the average peak intra-year decline has been 13.8%, literally the average historical correction. In other words, in any given year you should expect a correction, and be prepared to profit from it.

• good investors tolerate volatility and trust their diversified and prudently risk-managed portfolios
• great investors embrace volatility and harness it to their benefit

(Source: JPMorgan Asset Management)

For example, highly volatile companies such as Universal Display (OLED), are expected to react with far more volatility to any given market downturn. This is one of the most volatile companies on Wall Street.

Over the past 15-years the average annual volatility of OLED has been 59%, meaning in any given year it can plunge almost 60%.

                       OLED Monthly Returns

(Source: Portfolio Visualizer) 

In just the last 18 months OLED, which analysts expect to grow at 29% CAGR over time, has suffered six separate 10+% monthly corrections. It’s also experienced nine separate 10+% monthly rallies, including a 44% monster run in February 2019. What’s my point?

(Source: Imgflip)

For those with money to put to work in quality blue-chips, whether they boring old dividend kings like JNJ or hyper-growth names like OLED, short-term volatility is ALWAYS a great long-term buying opportunity. What if you’re already retired and have no money to put to work?

(Source: Imgflip)

As long as you never become a forced seller for financial or emotional reasons, volatility can never hurt you. This is why the #2 factor in long-term financial success (#1 is having a sufficient savings rate) is prudent risk management.

If you focus on the fundamentals of success and ignore the noise, including who wins on election day, and how long it takes to find out the victor, then you can avoid making a horrible mistake, such as selling all your stocks ahead of what the best economists and asset managers on earth expect to be a relatively short and mild downturn.

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SPY shares were trading at $343.95 per share on Tuesday morning, up $1.94 (+0.57%). Year-to-date, SPY has gained 8.40%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: Adam Galas

Adam has spent years as a writer for The Motley Fool, Simply Safe Dividends, Seeking Alpha, and Dividend Sensei. His goal is to help people learn how to harness the power of dividend growth investing. Learn more about Adam’s background, along with links to his most recent articles. More...

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