How Quickly Do Stock Markets Lose Their Obama Bounce

(Corrects title of Mario Draghi in third paragraph.)
The U.S. stock market is tanking the day after Barack Obama retook the presidency. What could it mean? Our best guess: With the election decided, investors have reawakened to the reality of an impending fiscal disaster in the U.S. and a festering crisis in Europe.

 

Throughout October and the first week of November, markets appeared to prefer the prospect of an Obama presidency (as we noted in a blog post yesterday). That pattern held in the first hours after Obama’s victory became evident: From 10 p.m. on Nov. 6 to 3 a.m. on Nov. 7, the December futures contract on the S&P 500 Index rose about 20 points. As late as 6 a.m., the stock market looked set to open with a strong gain.
Then the Germans showed up on the scene. At 6 a.m. New York time, their government reported a second monthly decline in industrial production, a data point later amplified by European Central Bank President Mario Draghi, who announced that Europe’s debt crisis is “now starting to affect the German economy.” Suddenly, a malaise that had seemed in remission was back in the news.
Meanwhile, the largely unchanged balance of power in Congress brought home an unsettling fact: Reaching agreement on a plan that would get the U.S. government’s debt under control without tanking the economy might be no easier than it was last year, when political intransigence brought the country to the brink of default. As a result, the recovery could fall off the fiscal cliff, the combination of spending cuts and tax increases coming at the end of this year unless Congress acts.
The lesson is clear. The U.S. and Europe will remain extremely vulnerable to sudden changes in investor sentiment unless they take ambitious steps to solve their respective debt problems. In Europe, that means completing an inadequate currency union. In the U.S., that means striking a balance between short-term stimulus and long-term fiscal rectitude, as well as between cutting spending and raising revenue.
Forward is the only way out.