Dow Jones Industrial Average monthly chart from 2000, with growth during Obama first term shown from 2009.
President Barack Obama’s reelection promises more strife with Republicans over taxes and deficits and leaves the stock market in search of signals of how the “fiscal cliff” issue will be handled and how the economy will fare under Democrats.
The stock markets did well during the first Democratic term but investors are wary about what may be ahead.
Obama’s reelection may give him some leverage in dealing with the Republican-controlled House of Representatives in the budget/tax battle since he can’t run again. But Republican House leaders have not given any clear signal they are willing to compromise, particularly on tax increases, setting up a battle that could make equity investors increasingly nervous.
The first stock market reaction signals were negative on November 7, the day after the election as the Dow Jones Industrial Average fell below 13,000 for the first time since September 4. Some analysts said traders were focusing on how Obama will deal with the fiscal cliff matter, although some of the losses were also attributed to discouraging debt crisis and economic news about Europe from Mario Draghi, president of the European Central Bank.
But over the longer term, stocks will focus on deficits and taxes and that may make the equity markets even more nervous. Obama and the Republicans were in a bitter fight during the first term over how to reduce $1 trillion annual deficits and how to trim the $16 trillion national debt. They also disagreed on tax hikes for the wealthy and where and how much to cut or revamp social and entitlement programs.
Fiscal cliff has been the most-uttered words in the financial markets and government circles in the past few months. Obama, the House and the Senate are faced with dealing with a package of spending cuts and tax increases of about $600 billion by year’s end. Stock market investors fear that failure to deal with this satisfactorily will cause more problems for the economy, hinder job growth and lead to downgrades of U.S. credit instruments by the rating agencies.
In his acceptance speech, Obama called for compromise and said he would work with leaders of both parties to reduce deficits, to reform the tax code and to reduce foreign oil dependence. The extent of the compromise on both sides will remain the key to success.
Some analysts said that if the fiscal cliff situation isn’t remedied, it would lead to the biggest single-year drop in the annual deficit as a percent of the economy since 1969. Its abruptness and its arbitrariness could upset the economy so much as to revert to a recession, they said.
Spencer Patton, founder and chief investment officer of Steel Vine Investments, a Chicago hedge fund, said the Obama reelection will be devastating for the stock market for two reasons. One reason is the increase in the tax on capital gains from 15% to 18.8% and the hike in taxes on dividends from 15% to 39.4 percent. For the capital gains tax, Patton said, there will be another 5% addition when the Bush tax cuts expire, making the figure 23.8 percent.
“Anyone who has long-term capital gains would be a fool not to sell before the end of the year, said Patton. “This is something that will be a black cloud over the market through the end of the year.”
Because both Democrats and the Republicans think they have mandates, fiscal cliff negotiations will again be pushed to the brink, up to the December 31deadline and probably extended past the deadline, creating further uncertainty for the markets,” he said.
Fiscal cliff wrangling may not be as disruptive as many think, despite the threat of downgrades of the U.S. debt rating, said Shawn Hackett, president and CEO of Hackett Financial in Boynton Beach, Florida. “Usually what you fret about doesn’t get you,” said Hackett of the fiscal cliff matter. “It’s what you don’t see.”
Hackett is concerned about how the Obama administration will deal with another recession, which he said could develop on a cyclical basis before the Democrat’s term is up. “What will be done during the next recession,” he asked. “Will they triple down, or quadruple down? We are at the point where the markets know that printing and borrowing won’t work. It just gets you in deeper.”
There are many theories about the effect of a presidential election on the stock market. An article in the money section of U.S. News refers to one of the most prominent election-year investment theories, that by Yale Hirsch, an investment adviser and the founder of Stock Trader’s Almanac. Hirsch developed the Presidential Election Cycle Theory, which contends that stocks decline in the year immediately following the presidential election, then go up during the next three years, no matter which party wins the election.
Some individual stocks can be affected by whichever party wins and the policies they pursue. An article in GoBankingRates.com by Beth McKenna suggested it is generally best to place little overall weight on politics when investing, especially for the long-term. “Stocks with strong fundamentals will usually perform well over the long-term, regardless of the shorter-term power fluctuations in the White House and Congress,” McKenna wrote.
The article noted, however, a report compiled by Bank of America equity analysts, Election 2012. The report noted under an Obama second term stocks in sectors such as life sciences & diagnostic tools, pharmaceutical distributors and alternative energy might fare better than some others.
Despite all the analysis and predictions, some analysts said the answer is not in the White House. Predicting stock performance based on who wins the White House is mostly a guessing game, according to James Kee, chief economist at South Texas Money Management.
“The general belief is that stocks tend to run up in election years when Republicans win and run down when Democrats win,” Kee told Reuters. “People expect tax cuts when Republicans run, but politicians never really deliver on what they promise and the market sells off in the following year. With Democrats, there’s a general feeling that there is going to be slow growth, but that’s not always the case.”