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Why the Stock Market Is Bummed About the Election

Rick Newman

On Election Day, stocks seemed upbeat about American democracy and the economy's future prospects. Even though polls showed the two presidential candidates in a dead heat, the stock market rose by nearly a full percentage point.

[PHOTOS: America Watches as Obama Wins Re-Election]

That honeymoon ended abruptly. The news that President Barack Obama won a second term has sent the market into a deep funk, with stocks down by more than two percent on Election Day +1. Manic investors are now giving the election results a big, fat raspberry.

Embittered Republicans might be tempted to attribute the plunge to poor confidence in Obama's ability to strengthen a weak economy. But that's probably not the case. While Obama is not personally popular on Wall Street, his policies have generally been good for the stock market and for big companies in general. In fact, many analysts have expressed relief that the easy-money policies of Federal Reserve Chairman Ben Bernanke are likely to stay in place, with fewer worries about a policy shift that might lead to higher interest rates, which might have been the case under Mitt Romney.

Instead, there seem to be three things going on as investors ponder the consequences of the election results. First, there were apparently some aggressive bets on Election Day that Romney would prevail, with sharp rallies in the stocks of companies likely to benefit under his policies. Analyst David Urani of Wall Street Strategies, for instance, pointed out that certain coal, defense and health care stocks rose sharply on Tuesday, probably bid up by investors hoping to cash in on favorable policy changes. Since they guessed wrong, the markets are now reversing those types of trades.

[RELATED: How Bernanke Helped Obama Win]

Second, investors who were obsessed with the election are now once again paying attention to important developments elsewhere, such as Europe. And surprise! Greece is once again teetering on the edge of withdrawal from the euro zone and a catastrophic default on its debt. That bogeyman is back.

But the biggest concern is the looming "fiscal cliff" that Congress must address by the end of the year, with about $800 billion worth of tax hikes and spending cuts due to go into effect if Congress doesn't act to prevent those measures from happening all at once. If Congress does nothing, all that austerity could shave GDP by about 4 percent, easily enough to trigger a fresh recession.

Many analysts believed that a Republican sweep on Election Day would have been the best outcome for swerving away from the cliff, since a government united under GOP leadership would be inclined to delay or cancel the scheduled tax hikes, which account for more than 80 percent of the hit to GDP. That may have been true, but it was also wishful thinking, since the GOP gained virtually nothing on Election Day. So investors must continue to grapple with bitterly divided government and all its ugly implications.

[READ: The Fiscal Cliff Just Got Steeper]

Many analysts still expect a compromise that spares the economy and perhaps even boosts the recovery. "The most important near-term question is still the fiscal cliff," says Russell Price, senior economist at Ameriprise Financial. "With all the rhetoric of the campaign now over, I think we'll see a deal come into focus rather quickly."

That would be ideal, but many skeptical investors recall the appalling spectacle in the summer of 2011, when it would have been simple to hash out a compromise to extend the nation's borrowing limit. Instead, politicians threatened to default on U.S. debt, regardless of the consequences. They finally did reach a last-second deal, but the theatrics were so alarming that Standard & Poor's downgraded the U.S. credit rating for the first time ever, and stocks fell by seven percent.

Perhaps the 2012 election has changed the tragicomic dynamic in Washington, but the gut reaction of investors is to prepare for the worst. That's what they're doing now, by selling.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.

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