The Post-Election Day Sell-Off

Includes: DIA, QQQ, SPY
by: Martin Lowy

As I wrote this, the stock market was in the midst of what may be its worst sell-off in more than a year. Why is it happening? Is the market reacting to Barack Obama's reelection? And is the sell-off a harbinger of more to come?

As usual, when there is a significant market movement, there are too many explanations. I have surveyed a number of the major financial websites, including the FT, the WSJ, the NY Times, CNBC, and Fox Business. Some of the current explanation suspects are:

  1. In a second term, President Obama will raise taxes as part of the fiscal cliff settlement. CNBC.
  2. A fiscal cliff settlement could push the U.S. economy into recession. NY Times.
  3. Fiscal cliff uncertainty. Fox Business.
  4. U.S. sovereign debt may be downgraded. FT.
  5. There will be no fiscal cliff settlement and the U.S. will have to default on its debt. FT.
  6. The European economy has stagnated. Several.
  7. Greece is going to have to be bailed out again-or default. Fox Business.
  8. Profit taking. WSJ and CNBC.

Which of these possibilities was not there before the election? None of them. Which of these possibilities was enhanced by the election results? Perhaps increased taxes was not as likely before President Obama was reelected. Let's look briefly at each of the 8 points.

1. Higher Taxes

"A newly re-elected President Barack Obama will push for higher taxes-including a dividend-tax hike that will cause a substantial drop in stocks, Pimco's Bill Gross told CNBC Wednesday." "Risk-averse investors," the CNBC website continued, "prefer dividend stocks, which are common in pensions and mutual funds even though they've largely underperformed other market indexes over the past four years." "Consequently, Gross said, higher dividend taxes would make those companies less attractive and thus take the stock market down 5 to 10 percent."

In my opinion, Gross is fear-mongering. Pension funds, for example, do not pay taxes. Their dividends are tax-free. The same is true for many types of foundations and endowments. For the most part, we are only talking about stocks that are owned by wealthy individuals. They do not control the market. But remarks like Gross's may move markets briefly.

2. Fiscal Cliff Recession

"Known as the fiscal cliff, this simultaneous combination of dramatic reductions in government spending and tax increases could push the economy into recession in 2013, economists fear," The New York Times reported. This is a fear that there will be no compromise, that all the cuts will become reality, and that only on that basis will the U.S. avoid a sovereign default. As I said elsewhere on S.A. Wednesday, I do not think the Republican Party is that bent on hari kari. But if it is bent on such hari kari today, then it must have been bent on it a day ago when some thought it might have more power to impose its way.

3. Fiscal Cliff Uncertainty

"The fiscal cliff looms large," says Fox Business. Yes, and it loomed the same way Tuesday and the day before that.

4. U.S. Sovereign Debt May Be Downgraded

"Fitch, the rating agency, reminded investors what is at stake. 'As reflected in the negative outlook on the [US's triple A] rating, failure to avoid the fiscal cliff and raise the debt ceiling in a timely manner as well as securing agreement on credible deficit reduction would likely result in a rating downgrade in 20132,' it wrote in a note," the FT reported."

And there was no change in that possibility Wednesday, either. Besides which, such a downgrade is, as I have explained in another post on S.A., rather nonsensical.

5. The U.S. May Default on Its Debt if There Is No Resolution of the Fiscal Cliff

The FT and others suggested that the market was worried about a U.S. sovereign default. Aside from that being nonsense, that was manifestly not true: "In contrast, investors flocked to the US Treasury market, with the securities headed for their biggest advance in almost three months. The yield on the 10-year note fell 12 basis points and was last trading at 1.62 per cent," the FT reported Wednesday. A market that is afraid of a default does not make gains.

6. The European Economy Has Stagnated

Several sources mentioned the stagnant European economy as a drag on the U.S. economy and stock market. But nothing significant has changed in that regard in the last week or more. See, for example, The New York Times.

7. Greece

Fox Business reported:

Traders were also paying close attention to Greece, where the country's parliament was set to vote on yet another austerity package aimed at easing its enormous debt burden. The vote is critical in securing another round of rescue aid from the European Union and International Monetary Fund and stave off a debt default that could send shockwaves through global financial markets.

Anyone who thinks that Greece guides the U.S. stock market should not be writing about financial matters. Greece's next default, whenever it occurs, is old news to anyone who participates in the market.

8. Profit Taking

"This is just investors, traders, etc., unwrapping their Christmas presents early," a WSJ blogger suggested this morning in a post that is no longer available. That suggestion may be on the mark. Elections, whichever way they are decided, seem to many investors to call for action of some kind. In some investors, the outcome strikes fear, and if they have gains for the year, they may elect to preserve them, despite the risk of foregoing more gains. That is not irrational conduct, even when it turns out to be wrong. There is going to be some heavy going in the give and take of politics between now and the end of the year. Markets could well get spooked from time to time.

Contrarian Advice

The best advice came from the WSJ's blog in a post that is no longer available: "The market's in risk-off mode right now, but a few hours ago it was the opposite, so tread cautiously in what's sure to be a day full of knee-jerk reactions."

As an investor (not a trader) I hope that the market continues the downward trend for a while. We need a buying opportunity. But I have my doubts that it will do so. I would not jump on the selling bandwagon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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