The Dow Jones Industrial Average had its worst day of the year yesterday, dropping 313 points or 2.36% as investors worried about the economic health of the eurozone and the effects of tax increases and spending cuts set to go into effect in 2013. The S&P 500 and the Nasdaq also suffered serious declines, falling 2.37% and 2.48%, respectively.
Market watchers gave many reasons for the decline — some blamed the election of Barack Obama, who ran on a platform to increase taxes on the wealthy, including capital gains taxes and taxes on dividends. If such policies were to go into effect, they would most likely depress asset values. Some investors were hoping that a more business-friendly Mitt Romney would be elected, and optimism for that outcome helped drive a stock market rally on Election Day. CNBC host Jim Cramer said yesterday that a belief in a late surge by Mitt Romney led investors to buy shares in financial institutions as well as coal companies, as Mr. Romney promised he would ease environmental regulations and roll back the Dodd-Frank financial reform bill. “I think the selling makes sense because there was a big run up yesterday, and a lot of those buyers were Romney buyers,” Cramer said.
But the main reason given by investors for the sharp decline was that Wall Street began yesterday to focus in earnest on the looming austerity measures that are set to go into effect at the end of the year. Current law dictates that the Bush tax cuts for all taxpayers will expire, as will the temporary payroll tax cut which was extended by President Obama and Congress in 2011. In addition, a round of cuts in military and so-called discretionary spending will begin in January.
Economists predict that if something isn’t done to modify these plans, it will suck as much as 4 percentage points of GDP growth out of the economy in 2013, enough to force it back into recession. “The minute such a deal is cut, we’ll boom. If one is not cut – and soon – we may well double-dip into recession,” Robert L. Reynolds, president and chief executive of Putnam Investments told Reuters.
In addition to fiscal cliff concerns, worry over Europe reared its head on Wednesday, after new economic data showed that business activity in the euro zone was weaker than expected. The data led European Central Bank head Mario Draghi to say,
“Germany has so far been largely insulated from some of the difficulties elsewhere in the euro area. But the latest data suggest that these developments are now starting to affect the German economy.”
Of course, Wall Street already knew that President Obama was the favorite to win the presidency, that the fiscal cliff was on the horizon, and that the European economy will likely be a mess for years to come. And it’s not like the stock market has performed badly under President Obama. As Ben Walsh at Reuters points out, the S&P 500 is up roughly 65% during the President’s first term, and more than 11% this year.
In the end, it’s impossible to pinpoint an exact reason for the decline. Markets rise and then they correct themselves all the time. And at 3 p.m. yesterday, House Speaker John Boehner gave the markets what should have been reason for muted hope that Republicans in Congress may be a little more willing to bend on their demands that the nation’s budget problems be solved without increasing taxes. Boehner gave a speech telling the President, “We want you to lead,” and indicated that House Republicans were willing to use a “balanced approach” to solve fiscal problems that includes new revenue, as long as serious tax reform and spending cuts accompany it.
Let’s hope the President and Mr. Boehner can actually play nice this time, lest we see many more terrible days like yesterday in the market.