For weeks, the bulls on Wall Street have blissfully wanted to believe that -- despite all signs to the contrary -- President Obama and House Republicans could come to an agreement on red-meat issues like tax hikes and spending cuts to avoid the fiscal cliff at the end of the year.

After GOP House Speaker John Boehner was unable to pass his "Plan B" -- featuring tax-rate hikes for millionaires and billionaires but no spending cuts -- this illusion has slowly been shattered. Thursday, Democratic Senate Majority Leader Harry Reid admitted that it looks like we're headed off the cliff just as the next, much scarier catalyst comes into view: the debt ceiling, which the Treasury says we will hit in a matter of days.

But as the fiscal cliff fiasco demonstrated, there is little reason to believe Washington will come to an agreement easily. That, along with the threat of a credit rating downgrade and signs of economic weakness, has investors headed for the exits in a big way.

This is a big reversal for many.

Despite signs that a new downtrend is being established amidst a political stalemate in Washington -- from various technical measures to our own Trend Indicator (more on that below) -- sentiment remains very bullish. Newsletter writers following the Nasdaq are now recommending one of their most extreme net long positions in more than a decade; a breathtaking reversal from their bearish positioning just five weeks ago.

These people were banking on a last-minute fiscal cliff compromise deal. Maybe they get one before the end of the year. I'm doubtful. A short-term deal will likely happen in mid-January. Everyone will sigh in relief.

But that only opens the door to the much more difficult task of raising the U.S. Treasury's debt ceiling (which will be hit on Dec. 31, but will be extended through cash-management measures until February or March). And that will require an agreement on the long-term, structural drivers of the deficit including entitlements and health care costs.

If you think the battle over raising taxes on millionaires and billionaires is tough, just wait.

The system is clearly unsustainable. There are a record 56.7 million Social Security recipients. But only 94.75 million full-time private sector workers in the country. And we've yet to tackle the issue of reducing health care costs and making the system more efficient.

And while the Federal Reserve is keeping Treasury yields low -- preventing bond investors from expressing their displeasure -- the credit rating agencies suffer no such hindrance. If a deal doesn't get done, or if it's accompanied by embarrassing political stunts and excessive delays, the Treasury will be hit by additional downgrades.

Standard & Poor's cut our AAA rating last summer in large part because of our dysfunctional politics.

Wednesday, Moody's warned that if there is no clear path on the fiscal outlook and debt trajectory next year, they will downgrade us too.

All the while, the economy is tipping -- along with Japan and Europe -- into a new recession as business spending dries up and consumers pull back as confidence falls.

Trading update

The risk-off complex is starting to move as a result of the market weakness, with the Dow Jones Industrial Average falling through its 200-day moving average. Treasury bonds, the U.S. Dollar, and volatility are all doing well. Everything else pretty much isn't. The exception is precious metals, which are hanging in there to my surprise (I expected additional weakness on the pop in the dollar).

As a result, I'm booking profits in my precious metals shorts and adding new exposure to Treasury bonds (long), energy (short), technology (short), and the euro (short) via the Direxion 3x Treasury Bull (TMF), Direxion 3x Energy Bear (ERY), ProShares UltraShort Nasdaq QQQ (QID), and the ProShares UltraShort Euro (EUO). I'm adding all three to my Edge Letter Sample Portfolio.

There are less aggressive ways to play these trends, including the UltraShort Oil & Gas (DUG) and the US Dollar Bullish Fund (UUP).

Disclosure: Anthony has recommended TMF, ERY, QID, DUG, UUP, and EUO to his clients. Be sure to check out his new investment newsletter, the Edge, and his money management service, Mirhaydari Capital Management. A two-week free trial has been extended to MSN Money readers. Click the link above to sign up. Mirhaydari can be contacted at anthony@edgeletter.c​​om and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.