Investors thought the election might answer some political questions. If that’s the case, Wall Street traders did not seem to like the answers.
Tuesday's election reaffirmed all the elements that led to gridlock during the past two years – reelecting President Obama and leaving the balance of power in Congress unchanged. In response, Standard & Poor’s 500 stock index has fallen 3.4 percent. Stock markets tried to rally Friday, but the effort had little energy with the Dow Jones Industrial Average closing up about 4 points for the day and down 3.2 percent since the election.
“What we are seeing is a hissy fit reaction,” says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore. “The last day or two they have been acting like 5 year olds, but we know that kind of thing passes very quickly, and they are on to the next thing.”
The next thing for Wall Street is mounting concern over whether Congress and the president can reach a compromise on taxes and the budget. If they don’t, the economy could go over what has been called the "fiscal cliff" as taxes automatically rise and spending gets pared. Economic analysts have said the tax increases and spending cuts would drive the economy into a recession.
Mr. Dickson thinks Wall Street may be overly pessimistic. D.A. Davidson has its roots in the Pacific Northwest, including many clients in Montana. Sen. Max Baucus (D) of Montana is the ranking member of the Senate Budget Committee.
“The word we are getting is that they are working beyond overtime for an acceptable compromise with a few high profile pieces that have to be hammered out,” says Dickson. “The stumbling blocks are diminishing.”
Friday afternoon, Mr. Obama said he would not accept any deal that did not increase the tax burden on those making more than $250,000 a year.
That could be a deal killer for the Republicans.
“I would like to believe they will compromise, but the cynic in me says Congress will allow us to fall off the cliff and allow the Bush tax cuts to expire so no one can be accused of raising taxes,” says Sam Stovall, chief investment strategist at S&P Capital IQ in New York.
Aside from the tax rate on the wealthiest, Wall Street is also worried that Congress will allow the tax rate on capital gains and dividends to rise. The current capital gains rate is 15 percent; if Congress does nothing it will rise to 20 percent. The dividend tax rate is currently 15 percent; if Congress is stalemated it will rise to a maximum of 36 percent. Both rates will also rise an additional 3.8 percent regardless of what Congress does because of a Medicare surcharge that is part of Obama's health-care law.
The prospect of capital gains and dividend rates rising, may also be another reason the stock market is falling, says Mr. Stovall.
“The prospect of those rates rising is incentivizing investors to lock in a much lower tax rate in 2012 than they expect to see in 2013,” he says.
Wall Street investors are also worried about the continued dilemma over Greece. Dickson is telling clients that “Greece is still an unsettled deal.”
He says the concern in the market is that the nation appears to be consistently missing budget targets. “It will be hard to present a case for another round of bailout funds,” he warns.
The last time the stock market had a good year but then tanked after an election was in 1948 when President Harry Truman surprisingly defeated Gov. Thomas Dewey. Leading up to the election, the S&P index was up 9 percent. It then fell 12 percent for the rest of the year.
If the stock market were to repeat that performance, the S&P which is currently 1,381 would fall to 1,270.
“If there is any consolation, the S&P rose 10 percent in 1949,” says Stovall.