Markets sell off after Obama’s win, amid concern over Europe

November 7, 2012

Investors are looking at the world in the wake of President Obama’s reelection victory. And they don’t like what they see.

The “fiscal cliff” looms, and the pathway for Obama and Congress to reach agreement and avert steep tax hikes and spending cuts Jan. 1 appears tenuous and uncertain. Moreover, the Greek Parliament was debating controversial austerity measures — passing them early Thursday — and investors are concerned that unrest over the bill’s cuts and tax increases could send a new wave of crisis across Europe.

Those concerns drove the U.S. stock market down Wednesday, with the Standard & Poor’s 500-stock index dropping 2.4 percent. The Dow Jones industrial average shed 313 points, also 2.4 percent. Major European markets were down, as well, including those in Britain, France and Germany.

Even more dramatic was the swing in the bond market. Money flooded into U.S. Treasurys overnight, driving the yield on 10-year securities down 11-hundredths of a percentage point, to 1.64 percent. When investors are antsy about the global economic situation, they tend to plow money into Treasurys as a safe harbor.

In other words, on Wednesday, every major market indicator was pointing toward more angst about the economic future. The trading floors of Wall Street, London and beyond were jittery. A measure of expected future market volatility known as the VIX index was up 9 percent.

Some of the slide could be seen as simply nervousness that Obama’s tax and regulatory agenda could damage corporate profits. That interpretation isn’t supported by the stock market’s movements during the race itself, however, when there was little correlation between movement in the polls and the market. (For example, Republican nominee Mitt Romney’s surge after the first presidential debate prompted no jump in stock prices.)

The unease over the tumultuous situation in Greece explains a drop in the euro against the dollar and a surge in Spanish and Italian borrowing costs.

But there is a strong case that a major reason for the market dive is that global investors are starting to look at what will happen to U.S. economic policy in the very near term — over the next two months — and see more reason for fear than for rejoicing.

The good news for investors was that the election’s outcome was reasonably crisp. Markets had feared a confidence-rattling series of recounts and legal battles. But Obama’s victory was decisive enough to prevent that possibility, and Asian markets initially rose overnight as television networks began calling the race for him.

As investors digest the results, however, they are looking at a broader set of risks presented by the election returns. The high-stakes brinkmanship that characterized the debt-ceiling standoff last year is looking like a mere preview of an even greater, more intense series of negotiations set to begin almost immediately.

“Returning to status quo likely means all sides see the voters as supporting their views, which means reaching compromise is not likely to get any easier,” said analysts at Bank of America-Merrill Lynch in a report.

Taxes are on track to rise sharply and government spending to be slashed if Obama and Congress fail to reach a deal before Jan. 1. To get its way, each side could threaten to allow the nation to go off the fiscal cliff, despite the risk of a recession. (How willing anyone is to actually let that happen is a different matter.)

And although control of the country might not have been left hanging in the balance, Tuesday’s results did nothing to change the basic dysfunctional dynamic between the two political parties. Congressional Republicans retained the House majority, an endorsement, in their view, of their hard-line stance against raising taxes. Democrats kept control of the Senate and the White House, which they see as an affirmation of their contention that deficit reduction must include tax increases.

“The reelection of President Obama removes one uncertainty that has been weighing on the markets over the last few months,” said Paul Ashworth and Paul Dales of Capital Economics in a research note Wednesday morning. “But they are none the wiser about if, how and when Congress will deal with the colossal tightening in fiscal policy scheduled to occur early next year.”

Against that backdrop, stock, bond and currency traders can be forgiven for feeling a bit on edge.

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