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Gail MarksJarvis: Economic uncertainty to linger, even after election

Main drama isn't likely to be who wins, but rather politicians' action — or inaction — on tax and spending decisions

Gail MarksJarvis

11:30 AM EDT, November 1, 2012

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No matter who emerges victorious in the Nov. 6 election, most analysts are expecting only a short-term calm in the stock market for the remainder of this year.

Investors typically cast their votes in the market based on what they imagine the newly elected president will do for the economy and their investments. Stocks often climb about 5 percent after an election, notes Deutsche Bank strategist Binky Chadha.

But there's a twist this year, one that prolongs the uncertainty even if President Barack Obama is returned to the White House or his Republican challenger, Mitt Romney, takes up residence there.

The main drama in a treacherous political and economic environment is expected to play out in late December and into 2013 as a running clock presses politicians into crucial, but unpopular, tax and government spending decisions. Some analysts think investors could be as unsettled by the scenes as they were in August 2011. That's when the Dow Jones industrial average plunged more than 500 points in a day amid congressional paralysis on extending the nation's debt ceiling and a punishing downgrade of the nation's debt rating by Standard & Poor's.

With the stock market now near a five-year high, investors have "left no buffer for bad news," warns Morgan Stanley strategist Gregory Peters. "We see significant risk — as high as 1 in 3 — that the U.S. fiscal 'cliff' ends badly enough to cause economic contraction."

The "fiscal cliff," named by Federal Reserve Chairman Ben Bernanke, involves about $800 billion in tax increases and government spending cuts that will happen automatically at the end of 2012 if Congress can't compromise or doesn't vote to kick decisions into next year. Bernanke has warned that if the nation plunges over that cliff, Americans will be left with less spending money and the nation likely will go into a recession.

While action isn't required until the end of December, analysts anticipate that the afterglow of the presidential election will quickly dissipate during the next two months as investors grow anxious about the December deadline and the potential outcome for the economy.

"Continued gridlock is a risk," Chadha said. On the other hand, "bipartisan compromise with orderly negotiations would see equities rally."

But current political polls indicate that neither candidate will win with a mandate. So analysts are not anticipating orderly negotiation on tax and spending cuts this year or next.

"A close race or disputed result could reduce the political capital of the winner, diminishing prospects for a compromise solution for the fiscal cliff in the lame-duck session of Congress," said Citigroup global political analyst Tina Fordham.

Even if one candidate earns a clear victory, there will be no mandate for that president-elect to take any particular action because before the election "no one addressed the core economic issues that face us," said Howard Simons, stock market strategist for Bianco Research. "They have only spoken in grand irrelevancies. We know we will have a different tax law, but no one put forth any concrete proposal."

Fordham said the groundwork for a compromise will be especially fragile if the election is so close that it prompts legal challenges, such as the George W. Bush/Al Gore election of 2000. When Gore announced after that election that he would contest the results in Florida, the Dow fell 280 points during the day. Bush entered office with Democrats asserting that the president had no mandate, and Fordham argues that it wasn't until after the 9/11 terrorist attacks that Bush had the political strength to pass tax cuts.

Some analysts expect what is being called a "bungee jump" off the fiscal cliff in December. In other words, current elected leaders will let the Dec. 31 deadline for actions on taxes and spending expire. As a result, American taxpayers will start 2013 with higher taxes, and consequently less spending money, as government defense cuts also take money out of the economy.

The assumption is that the stock market will react violently to the threat of a recession. Such turmoil could give politicians the cover they need to take actions their constituents might not like. In other words, a compromise could then be struck on taxes and government spending, even though Democrats and Republicans would arrive at measures in contrast to election rhetoric.

On the other hand, if Obama is re-elected and one chamber of Congress is controlled by Republicans, uncertainty about the economy and government tax and spending decisions could be long-lasting, notes Goldman Sachs economist Alex Phillips.

Although he thinks it's likely that Congress will cobble together some last-minute strategy that will put off a year-end fiscal cliff shock and postpone meaningful tax and spending decisions until 2013, "the congressional budget process may cease to function," he said. Agencies such as Standard & Poor's and Moody's could lower the rating on U.S. debt again — an action that would probably throw another scare into investors in stocks and bonds.

Given the amount of uncertainty that is likely to build before the end of this year, BlackRock's team of stock and bond strategists is suggesting a cautious approach for investors rather than any knee-jerk response to a post-election rally in stocks.

If investors do, indeed, run for cover as the fiscal cliff threat emerges, the BlackRock strategists anticipate stocks that pay dividends, and Treasury bonds and municipal bonds, will do well.

gmarksjarvis@tribune.com

Twitter @gailmarksjarvis