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%.

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 2018.1 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

Source: Federal Reserve Bank of St. Louis2

The Fed Raised Interest Rates Starting in 2015 – Stocks Still Moved Higher

Source: Federal Reserve Bank of St. Louis3

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, and the stock market may exhibit some short-term downside volatility as a result. If the volatility makes you uncomfortable, remember to reach out to your Zacks representative, that’s what we are here for. But also remember that some selling pressure is not an automatic signal of bearish times ahead. Short-term volatility is not the same thing as a longer-term downtrend.

Disclosure

1 The Balance. May 20, 2021. https://www.thebalance.com/fed-funds-rate-history-highs-lows-3306135

2 Fred Economic Data. May 21, 2021. https://fred.stlouisfed.org/series/SP500

3 Fred Economic Data. May 24, 2021. https://fred.stlouisfed.org/series/DFF

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