Monthly Market Commentary
The Effects of Tapering
Philip Blancato, Chief Market Strategist, Advisor Group
In recent major economic crises, the Federal Reserve has done all it can to get the economy back on track. One of the tools used by the Fed during these periods is the ability to lower interest rates at the short end of the curve. However, as we saw in 2008, during severe economic downturns, lowering rates alone is not enough to support the economy. During the Great Financial Crisis, the Fed and its chairman, Ben Bernanke, decided the economy needed another form of support and quantitative easing (QE) was introduced to the United States. The monetary tool was relatively new, as it was used for the first time by the Bank of Japan in 2001.1 QE is a unique form of monetary policy where a central bank purchases large quantities of treasury securities in the open market and therefore the amount of money circulating in an economy increases, which helps lower longer-term interest rates. This lowers the cost of borrowing, hopefully translating into the Feds ultimate goal of spurring economic growth. But what happens when the economy gets back on solid footing and the Fed starts to end QE? How do investors and markets react to this change in policy?
Like the 2008 Financial Crisis, the COVID-19 pandemic put the global economy on its heels, leading the Federal Reserve and its current chairman, Jerome Powell, to decide once again to institute a QE program. The current program involves monthly purchases of $120 billion in securities, $80 billion of which are treasury securities, while the remaining $40 billion are mortgage-backed securities. The bond buying program did help to stabilize financial markets, but now with an economic recovery underway, the question was raised of whether asset purchases are still necessary. As the economy reopens and Americans begin to spend, demand for certain goods and services have outstripped supply, driving up prices. Investors and economists worry that prices will spike too rapidly, potentially stalling the recovery. Price surges could curb consumer spending, the biggest driving force of the US economy. Inflation, as measured by the consumer price index (CPI) has increased 5.3% year-over-year and home prices have soared. According to FRED data for Q2 2021, the median sale price of homes was $374,900, an all-time high.2 If the Fed were to taper its asset purchasing program, long term rates could begin to increase, which could reduce those upward price pressures.
As interest rates rise quickly, in the short term, increasing volatility is common as market participants digest the information and begin to adjust to a new interest rate environment. For example, when interest rates rose quickly in March of this year, the VIX increased to as high as 28.57, above its long-term average of about 17.
A potential rise in rates also impacts asset classes differently. For example, in the first quarter of 2021, the 10-year treasury yield increased rapidly, moving to as high as 1.70% as fears of future inflation made its way through the market. With interest rates rising, growth-style equities saw their valuations decreasing as their expected future cash flows were being discounted at a higher rate. The Russell 1000 Growth Index fell -6.70% in a span of just 6 trading days.3 On the other hand, rising rates and economic growth benefitted value-style equities as these tend to be more cyclical in nature. Over a similar timeframe, the Russell 1000 Value Index had increased +6.18%.4
The “taper tantrum” of 2013 can be seen as a learning opportunity for the current Federal Reserve. In 2013, the Fed was not transparent in its plans to taper, and the news shocked the market. Following the announcement, the S&P 500 fell nearly -6% over the next week. 5 The
Federal Reserve and Jerome Powell announced in its September meeting that if economic growth continues, tapering will begin soon at a gradual pace. The consensus expectation is that tapering will be announced at their next meeting and will begin shortly thereafter. There are those in the camp that believe tapering should have already begun. This is due to the belief that the economy is more than capable of standing on its own and the fear that if the Fed does not act, there may be consequences. On the other hand, there are those who believe we should take a wait-and-see approach to tapering. This is in part due to the continuing risks COVID-19 is having on the labor market and the possibility that inflationary pressures are proving to be transitory. Nonetheless, if the Fed continues to be transparent in its plans to taper, the initial knee-jerk reaction may not be as severe compared to 2013 as the Fed and the market continue to navigate this change in policy.
S&P 500: The S&P 500® is widely regarded as the best single gauge of large-cap U.S. equities and serves as the foundation for a wide range of investment products. The index includes 500 leading companies and captures approximately 80% coverage of available market
Russell 1000 Index: The Russell 1000 Index Measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000 Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current
index membership. The Russell 1000 represents approximately 90% of the U.S market.
VIX: The VIX Index is a financial benchmark designed to be an up-to-the-minute market estimate of the expected volatility of the S&P 500 Index and is calculated by using the midpoint of real-time S&P 500 Index (SPX) option bid/ask spread.
CPI (headline and core): Consumer prices (CPI) are a measure of prices paid by consumers for a market basket of consumer goods and services. The yearly (or monthly) growth rates represent the inflation rate
Index performance does not reflect the deduction of any fees and expenses, and if deducted, performance would be reduced. Indexes are unmanaged and investors are not able to invest directly into any index. Past performance cannot guarantee future results.
Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect again loss. In general, the bond market is volatile; bond prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed-income security sold or redeemed prior to maturity may be subject to a substantial gain or loss. Vehicles that invest in lower-rated debt securities (commonly referred to as junk bonds or high-yield bonds) involve additional risks because of the lower credit quality of the securities in the portfolio. International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.
The statements provided herein are based solely on the opinions of the Advisor Group Research Team and are being provided for general information purposes only. Neither the information nor any opinion expressed constitutes an offer or a solicitation to buy or sell any securities or other financial instruments. Any opinions provided herein should not be relied upon for investment decisions and may differ from those of other departments or divisions of Advisor Group or its affiliates.
Certain information may be based on information received from sources the Advisor Group Research Team considers reliable; however, the accuracy and completeness of such information cannot be guaranteed. Certain statements contained herein may constitute “projections,” “forecasts” and other “forward-looking statements” which do not reflect actual results and are based primarily upon applying retroactively a hypothetical set of assumptions to certain historical financial information. Any opinions, projections, forecasts and forward-looking statements presented herein reflect the judgment of the Advisor Group Research Team only as of the date of this document and are subject to change without notice. Advisor Group has no obligation to provide updates or changes to these opinions, projections, forecasts and forward-looking statements. Advisor Group is not soliciting or recommending any action based on any information in this document.
Securities and investment advisory services are offered through the firms: FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., Triad Advisors, LLC, and Woodbury Financial Services, Inc., broker-dealers, registered investment advisers, and members of FINRA and SIPC. Securities are offered through Securities America, Inc., a broker-dealer and member of FINRA and SIPC. Advisory services are offered through Arbor Point Advisors, LLC, Ladenburg Thalmann Asset Management, Inc., Securities America Advisors, Inc., and Triad Hybrid Solutions, LLC, registered investment advisers. Advisory programs offered by FSC Securities Corporation, Royal Alliance Associates, Inc., SagePoint Financial, Inc., and Woodbury Financial Services, Inc., are sponsored by VISION2020 Wealth Management Corp., and affiliated registered investment adviser. Advisor Group, Inc. is an affiliate of these firms. 
1 Quantitative Easing (QE): Major Instances in History (managementstudyguide.com)
2 Median Sales Price of Houses Sold for the United States (MSPUS) | FRED | St. Louis Fed (stlouisfed.org)
3 Bloomberg (as of 9/17/2021)
4 Bloomberg (as of 9/17/2021)
5 Bloomberg (as of 9/20/21)