Projected Obama win has markets staring at fiscal cliff

Traders and investors on Wednesday said the best way for U.S. President Barack Obama to celebrate his re-election would be to avoid a budget crisis that could send the U.S. economy reeling.

Stock futures fell about half a percent after Obama edged out Republican Mitt Romney while bond futures rose. While the result ended uncertainty about regulation and monetary policy, some remained on edge about taxes and overall economic health.

Investors have had a tendency of downplaying problems emanating from Washington, only to find themselves surprised when lawmakers cannot get together on critical issues.

The $600 billion of automatic tax increases and spending cuts that could take effect in January and send the fragile U.S. economy into a tailspin is the next such issue that could bedevil markets.

"There will be an immediate shift to government gridlock and the fiscal cliff issue, and that will be a headwind for stocks," said Michael Yoshikami, chief executive officer and founder of Destination Wealth Management in Walnut Creek, California.

With Republicans retaining control of the U.S. House of Representatives, some investors feared compromise on fiscal reform would remain hard to come by, which could keep markets under pressure.

Economists fear letting all the tax hikes and spending cuts take effect at once would hammer consumer and business spending, push the U.S. economy back into recession and batter markets.

The market reacted harshly to Washington gridlock after failed legislation to backstop the banks in 2008 and, again during protracted talks to raise the U.S. debt ceiling in 2011.

"The real challenge is for (Obama) to bridge the differences with Congress and work to get in the middle," said Jason Ader, a former Wall Street gaming analyst and a Romney supporter.

"Markets will have a knee jerk reaction tonight and tomorrow and find support over the next few days," he said.

But Steven Englander, head of G10 foreign exchange strategy at Citigroup, warned that the fiscal cliff "could become a bigger issue down the road, and if we don't see progress quickly the market may reconsider how risk-positive the next few months will be."

That could hurt the U.S. dollar, should investors worldwide think the U.S. deficit will drag on the economy. European nations have been hamstrung by their inability to escape their heavy debts and lackluster growth.

Though markets came into the night expecting Obama to win, most traders and investors supported Romney, who raised more money on Wall Street than Obama.

Whitney Tilson, a hedge fund manager and one of the only managers in the $2 trillion industry to publicly endorse Obama for a second term, said he was optimistic that the two parties would compromise.

"This was a victory for moderates," he said. "I hope both parties recognize this and move toward each other -- to the center -- to address the pressing problems our country faces."

Billionaire investor George Soros, another outspoken Obama backer, said he saw the result "opening the door for more sensible politics. Hopefully, the Republicans in office will make better partners in the coming years, most urgently in avoiding the so-called fiscal cliff."

CLARITY ON THE FED, LESS ON THE ECONOMY

Obama's win did remove uncertainty about the future of Federal Reserve policy.

Romney had said he would have replaced Fed Chairman Ben Bernanke, whose dovish monetary policy has been a helped propel the gains in both U.S. bond and stock prices in recent years.

"Obama wins and will keep Bernanke and therefore the risk asset rally," said Tom Sowanick, co-president and chief investment officer at Omnivest Group in Princeton, New Jersey.

The benchmark S&P 500 has rallied 67 percent since Obama took office - one of the most impressive runs ever for stocks under a single president.

Benchmark bond yields, meanwhile, hit record lows despite a downgrade of the U.S. credit rating last year. Cumulative returns for all maturities on all U.S. Treasuries are at 14 percent since Obama took office, according to Barclays.

"Net-net, I think the market will say, ���Well, we never were that scared about the fiscal cliff anyway, and isn't it going to be great to have Bernanke at the Fed for the foreseeable future,'" said Michael Jones, chief investment officer at Riverfront Investment Group, with $3 billion in assets under management.

Gregory Whiteley, government bond portfolio manager at DoubleLine Capital in Los Angeles, said steady Fed policy could spark a slight rally in bonds.

But he said the prospect of higher taxes, and stiffer market regulation would likely keep growth sluggish.

"I don't think the result is good for economic growth, so there wouldn't have been much upward pressure on yields from that front," he said.

The U.S. economy has held up better than other advanced economies, but growth has remained sluggish and unemployment high. Economists expect about 2 percent growth this year.

Under a second Obama presidency, Wall Street will have to forgo trying to repeal Dodd-Frank financial reforms and instead continue to use their personal relationships in Washington to keep the law from harming the firms, said Karen Shaw Petrou of Federal Financial Analytics, a Washington-based research firm.

Wall Street has bristled at the reforms, which include stricter capital requirements for banks and the Volcker Rule that is intended to stop banks from making bets in the financial markets with insured deposits.

But some welcomed the changes.

"I don't think any reasonable observer would want to go back to the risk that we had in the system before the financial crisis," said Evercore CEO Ralph Schlosstein.

(Additional reporting by Tim McLaughlin and Svea Herbst-Bayliss in Boston, Atossa Abrahamian, David Henry, Rick Rothacker, Ryan Vlastelica, Sam Forgione, Nadia Damouni, Gregory Roumeliotis and Jennifer Ablan in New York, Doris Frankel in Chicago and Claire Sibonney in Toronto; editing by Lisa Von Ahn, Prudence Crowther, Andrew Hay and Leslie Gevirtz)