The Overnight Report: No We Can't

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By Greg Peel

The Dow fell 312 points, or 2.4% to 12,932, while the S&P dropped 2.4% to 1394 and the Nasdaq lost 2.5%.

It is now apparent that Tuesday night's Election Day rally on Wall Street was more about hopeful speculation of a Romney victory than it was about simple relief that the election would shortly be over. Those tipping a Romney victory put up some reasonable arguments in support, but at the end of the day they were very wrong. Obama has won the popular vote as well as comfortably winning the electoral college vote. This in itself is bad news for Wall Street, but worse still is the Democrats' failure to win the House.

Interestingly, it appears the Democrats would have held the Senate even if Romney had won the presidency. This is basically a rejection of the Tea Party, which lost representatives in both Houses after a brief two years in the sun since the mid-terms. Clearly America decided after this period that while economic recession is one thing, evolutionary regression is another.

Economic recession is nevertheless what is now feared, which harks back to the fiscal cliff. Realistically we're right back where we were this time last year when the Administration and Congress were deadlocked over fiscal policy and S&P subsequently downgraded its US credit rating. Romney's concession speech included an appeal for Republicans not to repeat 2011: "At a time like this we can't risk partisan bickering and political posturing. Our leaders have to reach across the aisle to do the people's work, and we citizens also have to rise to occasion". But Romney no longer has a voice.

House Speaker John Boehner has a voice however, and this morning (Sydney time) he was using it.

Boehner acknowledged that the American people have spoken, and that the President has the mandate. He also pointed out, nevertheless, that the people have also provided a Republican led House with a mandate. Yet he declared to President Obama that "we are ready to be led". The speech was more conciliatory than Boehner's stance of 2011 suggested, specifically indicating a willingness to accept new "revenues". This might imply higher taxes, but Boehner is not prepared simply to let the Bush tax cuts expire. He wants a full revamp of the tax code, providing for revenues to be increased not through simply raising tax rates, but by actually lowering across the board tax rates while at the same time closing entitlement loopholes that would result in a net increase of revenues.

If it is possible, it sounds eminently sensible. Boehner acknowledged, however, that such changes will be complex and cannot be achieved in the "lame duck" period between now and inauguration, or importantly before the January 1 fiscal cliff deadline. So it seems we are still in for a long period of debate and negotiation, even if concession may be an ultimate, positive solution. Boehner said he wants to offer "conviction not confrontation". Wall, Street, Americans and the world will be hoping he is true to his word. And clearly it will also require the Administration to be similarly open to a rethink.

Wall Street didn't like it, nonetheless. The Dow had been down around 360 points mid-session, but after the close in Europe, it staged a comeback to be down around 250 when Boehner appeared on screens. As soon as he concluded the Dow fell again to close just over 300 points lower. Wall Street does not like the concept of the Republicans potentially conceding to higher capital gains and dividend taxes, among other things.

Even if a fiscal cliff is avoided, the Obama win reinforces expectations of ongoing easy policy from the Fed. No more evident was this assumption than in the US bond market last night, with the ten-year yield falling 12 basis points to 1.63% as a "risk off", recession-fearing move with expectations of ongoing Fed bond purchases.

This also implies an inflation risk, but gold made its move on Tuesday night. Last night gold was little changed at US$1718.50/oz, with the US dollar index also only up 0.2% to 80.78 as a euro fall countered dollar selling. The Aussie is 0.2% lower at US$1.0416.

While not a lot has changed in Europe in the late run-up to the US election, Wall Street has clearly been inwardly focused up to now. Last night Europe reappeared in Wall Street's mindset when ECB president Mario Draghi suggested debt issues in the eurozone are beginning to take their toll in the zone's largest (and "saviour") economy. "Germany has so far been largely insulated from some of the difficulties elsewhere in the euro area," Draghi said at a conference in Frankfurt last night. "But the latest data suggest that these developments are now starting to affect the German economy."

At the same time, the European Commission cut its 2013 GDP growth forecast for Germany to 0.8% from 1.7%. The EC cut its net eurozone GDP growth forecast to 0.1% from 1.0%. One is forced to speculate as to whether even 0.1% is ambitious.

Draghi and the EC had European markets and the euro selling ahead of the Wall Street opening bell, only serving to compound the opening plunge. The German and French stock markets closed down 2%. Meanwhile, riots continue in Greece with a parliamentary decision on the budget still pending.

There was also an Apple factor last night, with last night's weakness pushing America's biggest company to the "bear market" threshold of 20% down from its recent all-time high. Whether or not such definitions are viable, technically the impact on all indices was notable.

Speaking of matters technical, the fall last night through 13,000 in the Dow and more importantly 1400 in the S&P 500 are weak signals that suggest ongoing technical selling. This is the biggest single day's fall on Wall Street in a year and the biggest post election day fall since 1948. Presumably we should net out against what proved to be an erroneous 133 point move up in the Dow on election day to gauge the true response, but either way it's bad.

Oh and incidentally, another severe storm is building up in the Atlantic threatening more rain and heavy snow. It's not quite another Sandy, but will certainly kick the US east coast when it's already down.

Base metals mostly gave back about 1% last night, but the big impact was felt in the oils. With increased US weekly inventories added to the mix, Brent fell US$4.25 to US$106.82/bbl and West Texas fell US$4.00 to US$84.71/bbl. Spot iron ore nevertheless rose US50c to US$121.60/t.

The SPI Overnight has fallen 39 points or 0.9%.

And so we enter another four years of a Democrat in the White House and Republicans in the House of Representatives. What happens from here on? It's a question that has already been discussed at length on business television this morning and will no doubt continue to be discussed all day in Australia. Quite simply, everyone has an opinion, but no one knows.

Look out for the Australian unemployment numbers today and an ECB rate decision tonight.


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