Stock markets fear US political gridlock Forget crunching numbers, counting cash flows and calculating earnings multiples - this was the week that investors set aside their spreadsheets and behaved like guests on a giant political discussion panel on Cable News Network. The election result may be settled, but its political meaning is not, and that means it is almost as hard as before to forecast the outcome of the urgent budget negotiations getting under way on Capitol Hill. The question of whether, and how, the US will avoid the recession-inducing $600bn of spending cuts and tax rises that has come to be known as the fiscal cliff worried investors so much that the S&P 500 went down 3.6 per cent in two days. The yield on a 10-year Treasury bond slipped 12 basis points, but observers were split on whether this was because the US was more likely to go over the cliff into recession, or because there would be a "grand bargain" budget deal that would lock in years of growth-sapping austerity further down the line. Meanwhile, an emerging question is whether the US can arrive at a budget deal without incurring another credit rating downgrade. Moody's and Fitch are threatening to remove the country's triple-A rating, while Standard & Poor's, which downgraded the US last year, is warning another cut is possible - depending on how the politicians behave. In this heady atmosphere, it is little wonder that investment strategists have turned political pundits. Here is John Briggs, strategist at Royal Bank of Scotland, for example, predicting a deal to avert the fiscal cliff and fix the US budget deficit: "The goal of the Republican party was to make things miserable for Barack Obama and have him voted out, but that failed spectacularly. Unless they stop obstruction for obstruction's sake, Republicans face being wiped out in the midterm elections. And here is Chris Krueger of Guggenheim Partners, warning that a deal is harder than most people think: "The starting White House position is a non-starter with congressional Republicans and should not be considered "grand."" The Congressional Budget Office says failure to avoid the fiscal cliff will send unemployment back over 9 per cent from just below 8 per cent now; the government will hit its $16.4tn debt limit in about early February if nothing is done, raising the spectre of default; and there is still no political agreement on how to reform retirement benefits to prevent the deficit rising out of control as the baby boomers retire over the next two decades. With each new pronouncement, the rating agencies narrow the options for politicians seeking to avoid a downgrade. While "going over the cliff" - that is, allowing the tax rises and spending cuts to kick in, according to current law - might theoretically improve the creditworthiness of the federal government, since it would slash the deficit in 2013, it would not impress Fitch. The rating agency said this week that "failure to reach even a temporary arrangement to prevent the fiscal cliff and a repeat of the August 2011 debt ceiling episode would mean that the general election had not resolved the political gridlock in Washington and likely result in a sovereign rating downgrade." Moody's was quick on the draw, too, coming out within hours of the election result to warn it would strip the US of its Aaa rating if a budget deal does not stabilise and then begin to reduce the size of the federal deficit relative to gross domestic product. US politicians and investors may be tempted to ask, so what? When S&P withdrew the country's triple-A rating last year, yields not only failed to spike higher, they fell further. The federal government is borrowing at a 10-year rate of 1.62 per cent now, compared with 2.56 per cent before the downgrade. Moreover, there were none of the financial market disruptions that some investors feared. "Financial markets know what the fiscal situation is in the US, why it is a problem and how it may or may not be fixed, and in that sense rating agencies don't add much by changing their letter or number," said Kevin Logan, chief US economist at HSBC. However, it does have consequences for other ratings, such as those for banks, insurers and other companies that hold concentrations of government assets, causing a cascade of rating changes. Sorting all that out can create some volatility. Financials have been among the sectors hardest hit by the status quo election result, and the perceived increased risk of gridlock, but they are by no means the only stocks under threat. Next in the bears" sights are dividend stocks. James Paulsen, chief investment strategist at Wells Capital, said a budget deal was likely to include a rise in taxes on dividends, hitting telecoms and utilities. "They are far too popular, over-owned, and their valuations not great," Mr Paulsen warned. After seeing the rush to sell stocks this week, investors are predicting similar big moves as the budget talks begin, the political posturing increases, and as Wall Street's new class of political pundits swing between pessimism and optimism. At the rating agencies, though, a cooler, watchful eye prevails, and there is no rush to judgment. Steven Hess, Moody's sovereign ratings chief, said: "It will be some time before we see whether the two political sides have become more willing to reach a compromise, no longer in election mode."