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  1. Retirement Income Channel
  2. Taper Talk Returns But It Doesn’t Have to Be 2013 Again
Retirement Income Channel
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Taper Talk Returns But It Doesn't Have to Be 2013 Again

Tom LydonOct 29, 2021
2021-10-29

When the U.S. economy appeared to be on fragile ground, the Federal Reserve stepped up to support the bond market by purchasing massive amounts of corporate bond exchange traded funds. It also purchased billions upon billions of dollars of Treasuries and mortgage-backed securities (MBS).

The thing is, the central bank can’t keep its balance sheet bloated into perpetuity. Translation: It has to taper, and when investors hear “taper” and the Federal Reserve, they instinctively think of 2013 when that tapering regime prompted a sell-off in stocks.

Recently, the Fed telegraphed tapering plans, and while that stoked a rise in 10-year Treasury yields, equities are continuing to trade higher, too. That could be a sign that investors won’t have to endure a sequel to the 2013 taper tantrum.

“In reaction to the looming taper, along with pressure from elevated inflation, Treasury yields have jumped to the highest level since April,” says Nationwide’s Mark Hackett. “Additionally, the 30-year mortgage rate shot to its highest level in over a year, at 3.25%. Equity investors have largely shrugged in reaction to the tapering conversation. While the market experienced six weeks of weakness and volatility, the S&P 500® Index surged to a fresh record high last week despite significant challenges in supply chains, elevated inflation and slowing economic and earnings growth.”

Of course, it’s reasonable to ponder just how well stocks will perform without asset-buying by the Fed. Historically, the relationship between the Fed’s bond buying and S&P 500 appreciation has been quite cozy indeed.

“Looking at the longer-term trend, however, it’s reasonable to question the degree to which aggressive central bank policy and resulting liquidity has helped power the staggering equity market returns since the financial crisis,” adds Hackett. “Over the past 12 years, we have seen the S&P 500 increase by 339%, while the Federal Reserve’s balance sheet has increased by 296%. That amounts to a correlation of weekly results at 90%.”

Additionally, stocks are looking pricey against a tapering backdrop, and that could motivate some investors to pare equity exposure.

“There’s more to the equity market strength than simply the size of the Fed’s balance sheet, but the S&P 500’s price/earnings ratio has steadily increased over this period, currently trading at 21-times forward earnings. A slowdown (and ultimately elimination) of asset purchases could put a dampener on the level of liquidity in the system. This could additionally put downward pressure on equity market returns,” concludes Hackett.

For more news, information, and strategy, visit our Retirement Income Channel.

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