Stop Worrying, and Learn to Love The Taper
As the Federal Reserve prepares for its Federal Open Market Committee meeting next week, many investors are getting nervous that the central bank’s forthcoming monetary policy announcements will kill the stock market rally.
Fed Chair Jerome Powell last month signaled that tapering might soon begin, without providing a specific timeline. (Don’t blame Powell; it’s his job to be enigmatic.)
If you’re biting your nails, I suggest you relax. There’s an old expression on Wall Street: Don’t fight the Fed. Allow me to add a corollary: Don’t fight the taper.
Over the past few weeks, we’ve been treated to compelling new data supporting the idea of economic strength across many of the world’s most important economies, including the United States, China and Europe. Data on manufacturing activity in all three economies has not only pointed to accelerating growth, but it has also come in ahead of analysts’ expectations.
These numbers are broadly supportive to stocks since they suggest improving corporate profits will follow, but they also bolster the case for the Federal Reserve to start tapering its monthly bond purchases. The central bank can’t stay in crisis mode forever.
When the Fed increases interest rates and squeezes credit, it causes money supply growth to nosedive, an unmistakable sign that the stock market will soon stall. Historically, money supply growth has exhibited a close correlation with stock price movements. An increasing money supply boosts stocks; decreasing money supply puts the brakes on stocks.
So, with the Federal Reserve poised to taper, should you be worried? Not really.
Tapering does not equate to tightening credit conditions. The U.S. central bank will continue to pump money into the system at a staggering pace. Nevertheless, investors are understandably concerned about the impact the reduction in liquidity will have on markets both here and abroad.
The Fed is currently buying $120 billion worth of securities every month from the market. The following chart shows just how enormous the Fed’s balance sheet has grown:
Fears of COVID Delta have waxed and waned, roiling markets depending on the headlines of any given day. But for the time being, rising optimism toward the economy should foster greater corporate and consumer spending alike. That should offset adverse effects from steeper long-term interest rates.
Even with the eventual reduction and end of quantitative easing (QE), monetary policy will remain highly accommodative for the foreseeable future.
Two things to keep in mind: One, even if the Fed does begin to reduce the size of its bond purchases, it will very likely do so in small incremental steps. Think of it as “Taper Lite.” Meanwhile, it will keep reinvesting the principal from maturing bonds, and will therefore still provide ample liquidity.
Second, the Fed doesn’t want to prematurely reduce monetary stimulus, so when it finally starts to taper QE, the economy will likely be on surer footing than it is now. After being spoiled by Fed-injected monetary steroids, investors may have forgotten that strong economic fundamentals are actually good for stocks and commodities. In other words, tapering is actually a bullish indicator.
And the bulls are still in charge. On Wednesday, the following major U.S. indices racked up these gains: the Dow Jones Industrial Average +236.82 points (+0.68%); the S&P 500 +37.65 points (+0.85%); the NASDAQ +123.77 points (+0.82%); and the small-cap Russell 2000 +23.02 points (+1.11%). U.S. Treasuries fell. In pre-market futures trading Thursday, the main indices were little changed.
Hard choices, hard assets…
Stocks have racked up a good year so far, but risks are increasing, among them rising inflation, high valuations, and the possibility of a geopolitical “black swan.”
While the Fed’s clear lack of hurry to wind down QE provides some assurance for the financial markets, the S&P 500 currently trades at a 12-month forward price-to-earnings ratio of 22.2, well above historical norms.
That’s why there’s enormous potential this year and beyond for gold prices to rise relative to stocks. When markets get bumpy and uncertainty reigns, investors typically turn to the safe haven of the “yellow metal.”
Gold provides both insurance and growth potential for your portfolio during crises. There are several ways to increase your exposure to gold, including gold miners, funds, or even physical bullion itself. Your choices depend on your investment profile and tolerance for risk. To learn more about hard asset investing, visit this link.