Obama's New Opponent: The Fiscal Cliff

Worries about upcoming decisions in Washington could already be unnerving investors and sending stocks lower.

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President Barack Obama spends most of his time on the campaign trail focusing on his Republican challenger, Mitt Romney. But a third-party spoiler has entered the race: the so-called fiscal cliff.

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The cliff has been in place for months, and there's nothing new about the huge set of tax and spending decisions, affecting more than 6 percent of GDP, that need to be made by the end of the year. The question all along has been whether the prospect of a major disruption in the economy, courtesy of Washington, would torpedo the economy during the crucial few weeks leading up to Election Day, or remain a latent threat that doesn't affect the real world until later.

It now looks as if the cliff race will go down to the wire, with Obama turning out lucky if looming political decisions don't give voters one more reason to feel anxious about the economy. In fact, there are already some signs that the halting recovery is being held back by political factors, with bigger disruptions possible any minute.

Concerns about the fiscal cliff have been creeping into the real economy since the summer, when business leaders started to suggest they might put off big decisions on spending and hiring until it was clear whether Congress would tumble over the cliff, or avoid it. That's sensible, since the combination of tax hikes and spending cuts due to go into effect — totaling more than $700 billion — could easily trigger a recession if Congress lets them all happen at once.

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Optimists figure Congress will make some kind of last-minute deal, and Obama himself said during the last presidential debate that the spending cuts — known as a sequester — "will not happen." But the tax hikes are still looming, and the manner in which the whole thing gets worked out could be messy. One possibility is that all of the spending cuts and tax hikes take hold as scheduled, only to be rolled back retroactively a few months later once the next Congress has had time to work out a deal.

Business leaders and investors aren't happy about that kind of scenario, and their displeasure is starting to show up in various measures of the economy. Morgan Stanley's latest gauge of business conditions fell sharply in October, after a big gain in September following the Federal Reserve's latest stimulus effort. A survey of Morgan Stanly equity analysts showed 51 percent of them followed companies that have downgraded their outlook on account of uncertainty caused by the fiscal cliff.

The stock market, meanwhile, has begun to skid, falling more than 3 percent from the 2012 peak it hit in mid-September. That's partly due to weak corporate earnings that companies have been reporting for the third quarter. But analysts expected a slowdown, so it's possible that the cliff, along with other factors, is also spooking investors and causing a selloff.

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There's an unusual divergence, in fact, between the confidence levels expressed by business leaders and consumers. Moody's Analytics points out that since July, its business-confidence index has been falling sharply. But consumer confidence, as measured by the University of Michigan and others, has been rising. That could be because business leaders are intently aware of the fiscal cliff and its ramifications, while ordinary people haven't been paying much attention to it.

Bank of America Merrill Lynch thinks the markets still haven't accounted for all the mayhem the fiscal cliff could cause. "Markets have yet to price in a meaningful fiscal shock," the bank's economists explained in a recent research note. If the fiscal cliff were to be resolved in a reasonable way, Merrill expects the S&P 500 index to end the year around 1450, which would be about 2.5 percent higher than it is now. But Merrill predicts the index could fall to 1250 if Congress misses the end-of-year deadline and allows all the pending measures to go into effect. The bank forecasts a further plunge, to 1000, if a deadlock over the cliff persists long enough to cause a recession.

Is the market's recent decline the beginning of such a correction? Obama obviously hopes not, since a plunging stock market tends to make everybody feel bad, even people who don't hold stocks. Like a lot of other Americans, Obama can't get to Election Day fast enough.

Rick Newman is the author of Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.