Will The Taper Tamper With Investments?
Investing is laying money out now, to get more money back in the future.
— Warren Buffett
At the recent annual US Federal Reserve’s symposium at Jackson Hole Wyoming, Fed Chair Jerome Powell highlighted that 2021 could see the start of the central bank’s tapering. Tapering means the US Federal Reserve (also known simply as ‘Fed’) likely will begin cutting the amount of bonds it buys each month, so long as economic progress continues. Analysts are predicting a tapering announcement that could come as soon as the Fed’s Sept. 21-22 meeting.
The last time that investors had heard of tapering was in 2013. During that period, markets wobbled for a while with bonds being the most badly affected of all asset classes, suffering a significant loss over a short period of time. The event was then dubbed the “Taper Tantrum”.
With a fresh round of tapering looming on the horizon, how worried should we be of our investments? Should we be hiding away in cash or some other assets? Let’s lay out the facts.
Economic Comparisons
We can refer to the 2013 taper as a close proxy to what could happen in the market. However, the comparisons would be imperfect due to differences in economic situation and the world in general in 2013 as compared to now. For instance, the economy is much earlier in its expansion, the cyclical bull market is younger, bond yields are lower, economic growth is higher, inflation is higher, and unemployment is lower. (This can be seen in the numbers detailed below.)
Market Performance
What about market performance? The chart below shows the performance of US stocks represented by the S&P 500. The blue line shows what happened to the market during the 2013/2014 Fed taper, whilst the orange line shows the current market cycle. You will see that stocks were relatively unaffected by the taper in 2013. Stocks still generally continued their upward march when the Fed was talking about it, and when the program was eventually implemented.
Another appropriate comparison would be to look at a chart of stock/bond ratios. Essentially, the stock/bond ratio is calculated from dividing the performance of global stocks (MSCI All Country World Index) by global bonds (Bloomberg Barclays Global Aggregate Total Return Bond Index). Again, the performance of stocks led the charge shown by the blue line during the 2013/2014 taper. So despite what happened in bond markets during the last tapering round, stocks were relatively unaffected.
Thus, a diversified basket of stocks are relatively unaffected by tapering; this means you don’t need to worry so much about that portion of your portfolio. But what about bonds? The logical conclusion for tapering is that if the Fed were to reduce its bond purchases, it would make sense that bond prices would fall and as a result, rates rise. Do rising rates automatically translate to losses? Research from Dimensional Fund Advisors on changes in interest rates on the performance of bonds shows no clear relationship between losses and rate rises.
The info and statistics shown here should be a useful guide for investors that are trying to make sense of what could happen when the taper occurs. Essentially, like the illustration at the beginning of the article, if you are investing for the long term, what happens in the next few months should be of little concern to you. If you would like further assistance in making sense of what is going on financially in the world, or need a second opinion on your investments and finances, feel free to reach out and speak with us.
