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Dow dives 2.4% as fears rise of budget chaos

A trader worked on the floor of the New York Stock Exchange as the Dow Jones Industrials lost over 300 points.

JUSTIN LANE/EPA

A trader worked on the floor of the New York Stock Exchange as the Dow Jones Industrials lost over 300 points.

Stocks took a steep post-Election Day plunge, as investors worried that a returning President Obama and Republicans will fail to reach a deal to head off a slew of tax increases and spending cuts scheduled to kick in at the start of next year.

The Dow Jones industrial average dropped 313 points, or 2.4 percent, to 12,932.73, its worst one-day showing of 2012. Analysts said investors were imagining a worst-case scenario in which Obama and lawmakers fail to reach a compromise in time.

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“They’re concerned that some kind of deal is not likely in the near term,’’ said Lisa Emsbo-Mattingly, director of asset allocation research at Fidelity Investments in Boston. “If I were a policy maker and I didn’t want the market to go down 300 points, I would be getting on the phone as quickly as possible and talking to as many people across the aisle as possible. That would turn the market around.”

The so-called fiscal cliff everyone was talking about Wednesday is a combination of tax hikes and spending cuts intended to reduce the federal deficit. Wall Street bet heavily on Mitt Romney winning the election, hoping he and Republicans would extend the deadlines.

Now, investors fear Capitol Hill gridlock will persist, and that weighed heavily on stock markets Wednesday.

“You’ve got pretty much the same recipe as before — a Democratic president and House Republicans,’’ said Nigel Gault, chief US economist for IHS Global Insight in Lexington. If Obama insists on higher taxes and Congress refuses, he said, “You hit the cliff.”

But few believe Washington will let that happen, at least in its entirety. Such deep spending cuts and sharp tax increases all at once “would be devastating to the US economy,’’ Emsbo-Mattingly said. For instance, Fidelity estimates it could result in corporate profits dropping by 20 to 30 percent.

J.P. Morgan Funds global chief strategist David Kelly said the best situation would be for Obama and House Speaker John Boehner to emerge from the White House with a deal in December.

“You really can’t go too far into 2013 without causing chaos,’’ Kelly said on a conference call with financial advisers and reporters.

Otherwise, he said, companies will have to start withholding more from workers’ paychecks and other taxes will also rise.

“There will be a white-hot rage in America, and it will be directed probably at whoever appears to be the most intransigent in the debate,’’ Kelly said, citing new pressure on Republicans to compromise.

Beyond the fiscal cliff, the debt ceiling also promises to be a prominent issue in the first quarter of next year.

And while there are signs the US economy is picking up, fresh threats of recession in Europe also affected financial markets Wednesday, according to Bernard R. Horn Jr., president and portfolio manager of Polaris Capital Management, a Boston investment firm.

Financial and energy stocks were among the hardest hit, as investors in both sectors assumed more regulation would come their way. The Standard & Poor’s 500 Index fell 2.4 percent to 1,394.53, and the Nasdaq slid 2.5 percent to 2,937.29.

“We spent huge amounts of money and incalculable amounts of human capital” on the election, Horn said. “And after that whole process, we basically get that same gridlock government. And everybody’s hoping things will somehow change.”

IHS’s Gault echoed others who said Republicans have the most to lose if a fiscal solution isn’t found before January and people start noticing their paychecks are shrinking.

“They can’t just say ‘No, no, no,’ indefinitely,” he said.

Beth Healy can be reached at bhealy@globe.com.
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