Should You Fear the Fed Tapering?
A high percentage of financial commentary these days tends to focus on inflation worries, Fed tightening, and government spending. Most of the commentary is negative.
One of the worries I read about quite a bit are concerns surrounding Fed “tapering,” which is the term used to describe a reduction in bond purchases (QE). Many see Fed tapering – or even just the idea of tapering – as bearish. Somewhere along the way, Fed tapering became synonymous with downside stock market volatility, and/or doom for the economic expansion and bull market. But I don’t think you should fear it.
For one, the historical evidence connecting Fed tapering to market downturns is not very strong. Fed tapering first became a thing back in summer of 2013, when then-Fed Chairman Ben Bernanke signaled gradual reductions in QE bond purchases. True, the stock market endured some short-term selling pressure in the midst of the tightening, but it did not last very long. From the time Ben Bernanke announced QE would be reduced (summer 2013) to the actual end of QE (fall 2014), the S&P 500 went up over +20%.
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The Fed did not end the tightening cycle then, however. Many readers may remember that the Fed started raising interest rates in December 2015, pushing the fed funds rate from 0.5% in December 2015 up to 2.5% in December 2018.2 I am not saying there was no market volatility in the wake of the monetary tightening – there was. But for long-term investors, short-term market volatility should not be much of a factor. Market returns matter over years and decades, not weeks and months.
As you can see from the two charts below, Fed tightening caused a few blips and pullbacks during the last bull market, but QE tapers and rate hikes were not powerful enough to prevent the market from pushing higher over time.
The S&P 500 Over the Last Decade
The Fed Raised Interest Rates Starting in 2015 – Stocks Still Moved Higher
To take a bit of a contrarian view, I would welcome a Fed announcement to taper and eventually end bond purchases. In my view, Fed intervention keeps downward pressure on long-dated U.S. Treasury bond yields, which squeezes bank profits and removes incentives for more bank lending – not great for the economy. In my view, the Fed should be taking steps to try and steepen the yield curve – not flatten it. I think ending QE would be a step in the right direction, and it gives investors another reason not to fear the Fed taper.
A final reason not to fear the Fed taper: corporate earnings and economic growth matter more than the Fed, in my view. All too often, investors can get caught up in financial media narratives – like inflation and Fed tightening – and forget about the central role that earnings and growth play in equity market performance. I think we are in the early stages of a strong run-in corporate earnings and economic growth, as restrictions approach being lifted fully, nationwide. The economy is ready to charge ahead, in my view, which carries more weight than Fed minutes.
Bottom Line for Investors
Fed tapering and tightening in the previous cycle did not prevent the S&P 500’s bull market from persisting, and I doubt it will this time around, either. As somewhat of an anecdote, the Bank of Canada and the Bank of England recently pared back bond purchases by 25%, and neither equity market has felt much of a negative impact. In fact, they’ve both recently hit all-time highs.
At some point in the not-too-distant future, the Fed will need to rein in some of its monetary accommodation, but investors should not take it as an automatic signal of bearish times ahead. Short-term volatility is not the same thing as a longer-term downtrend.
If you haven’t already, now is the time to consider focusing on your asset allocation and portfolio diversity. Even with so much uncertainty, don’t time the market! Find the right strategy that tailors best to your long-term financial goals and needs. We recommend that investors focus on key data points and economic indicators when making financial decisions.
To help you do this, I am offering all readers our Just-Released May & June 2021 Stock Market Outlook Report.
This report looks at several factors that are producing optimism right now and contains some of our key forecasts to consider such as: If you have $500,000 or more to invest and want to learn more about these forecasts, click on the link below to get your free report today!
2 The Balance. May 20, 2021. https://www.thebalance.com/fed-funds-rate-history-highs-lows-3306135
3 Fred Economic Data. May 21, 2021. https://fred.stlouisfed.org/series/SP500
4 Fred Economic Data. May 24, 2021. https://fred.stlouisfed.org/series/DFF
5 Zacks Investment Management reserves the right to amend the terms or rescind the free Stock Market Outlook offer at any time and for any reason at its discretion.
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