Fiscal cliff lurks menacingly over Obama's victory

Economists, fund managers and strategists have tentatively welcomed the stability that they say Barack Obama’s presidential election win will bring financial markets – as well as the potential for more quantitative easing – but the challenge of averting a ‘fiscal cliff’ has curbed any real enthusiasm.

After a more resounding victory for the Democrat incumbent than may people had expected, JPMorgan chief global strategist David Kelly said there is now enormous political pressure on the Republican Party – which may see the need to seek more centrist, populist ground – not to obstruct a deal that would see poor American workers opening sharply reduced pay packets in January when tax increases and spending cuts would come into force. 

‘They realise that being extremist on these issues is actually hurting them,’ Kelly said. ‘I don’t think there is much risk that they won’t come to a compromise.’ The question is when a deal will be struck.

Fears over split Congress

Economists say that the result of the congressional elections – with the Republicans retaining the House of Representatives and Democrats holding their majority in the Senate – is as important as that of the presidential elections. ‘The split Congress will not make it easier to deal with the fiscal challenges of the next few years,’ said Bernd Weidensteiner of Commerzbank.

The International Monetary Fund, US congressional debt office, as well as independent economists and investors have said the US economy could fall back into recession if this is not achieved before January.

There is debate as to whether this risk has been priced into financial markets. ‘I remain underweight US corporates across all my portfolios, as the risks of the fiscal cliff on US growth have not been priced into US credit markets,’ commented Michel Canoy, a bond fund manager at Legal & General.

How bad is the fiscal cliff?

But there has been a growing chorus of investors warning that the fiscal cliff is now the greatest threat to the world economy.

Kelly said investors might be tempted to sit on cash until a deal is reached. ‘If the US gets past the fiscal cliff issue and past the uncertainty caused by the election it makes US stocks look pretty attract relative to equities across the world.’

The impact on investors

Any relief in the markets today at the clarity brought by the election result was short-lived with developments in Europe putting paid to a brief move higher on equity markets.

‘The relief of having Obama president lasted one and half hours,’  Stewart Cowley, a bond fund manager at Old Mutual, said, in relation to the FTSE 100's brief rise this morning before global markets headed lower. Cowley welcomed the clarity an Obama win brought, but nonetheless said the election result hadn’t prompted any changes in the bond funds he runs. ‘We remain in defensive mode’, he said.

Investors remain divided as to which candidate would have been better for different asset classes. Republican candidate Mitt Romney was deemed better for equity markets, as Obama has said he would raise tax rates on capital gains and dividends for the wealthy. Romney was seen as more pro-business, with a de-regulation agenda that was, as Kelly says, ‘more sympathetic to the financial services industry’.

Tana Focke, picking through the potential winners of an Obama victory, said: ‘I’m thinking of buying a hospital’. Focke, who runs the Smith & Williamson North American Trust , a Citywire Selection pick, says hospital operators are ‘obvious beneficiaries’ of Obama's win which means his healthcare reforms won’t be overturned.