Taper Tantrum 2.0 | Stock Talk Podcast

On June 1st, The Federal Reserve officially began its second try this decade at “Quantitative Tightening” programs. This is also referred to as “QT.” Recently, a lot of noise has been made that this might be disastrous for the financial markets over the next 6 to 12 months. The first time the Fed went down this path was in 2013 and 2014. We want to review the specifics of the current QT timeline and refresh investors memories on what happened when the Fed went down this path nearly a decade ago. Call this video Taper Tantrum 2.0 and what it might mean for your portfolio; historically, it’s not what you think.

I am Chris Perras with Oak Harvest Financial Group, here in Houston, Texas, and welcome to our weekly stock talk podcast. Before we get into this week’s topic on the Fed balance sheet tapering and what it might mean to your investments, please take a moment to click on the subscribe button and click on the notification bell so you will be alerted when our team uploads our latest content.

This week’s topic is to help address the recent concerns around what might happen to the markets as the Federal Reserve starts its new quantitative tightening program. Recall Quantitative tightening, or QT, is just a fancy term for the Federal Reserve not buying Treasury bonds and mortgage bonds. Instead of buying assets to stabilize markets, the Federal Reserve will be letting these assets run off their balance sheet and back into the markets. While they are not directly selling bonds into the market yet, we are essentially removing a massive buyer from the fixed-income markets.

Remember, this buyer has been present each and every week since they reinitiated this program as part of the emergency measures enacted to kick start the economy and markets from a covid recession in the second quarter of 2020. The central bank’s balance sheet has roughly doubled in size during the coronavirus pandemic as it purchased both Treasuries and mortgage-backed securities to smooth market functioning and ease monetary conditions. Now, the Federal Reserve is starting to drain assets from its $9 trillion balance sheet and will do so at nearly twice the pace it did in its previous “quantitative tightening” that began in late 2013 and 2014.

The minutia of current QT is this; it will go from zero to $95 billion per month in the span of three months. On June 1st, it started with $47.5 billion a month for the first three months. They let $30 billion of Treasuries and $17.5 billion of MBS run off the balance sheet. It will increase to the full $95 billion per month by September. The plan is to rely on redemptions of short-term bonds which mature in a year or less and continue to hold longer-dated assets.

First off, one might think that with the Fed not in the market buying, Treasury interest rates would go markedly higher.

Well, if you have watched any financial news over the last 6 months, you are probably aware that interest rates have already spiked higher, with mortgage rates now around 5% and 10-year Treasury yields now near 3%. They have already moved materially higher since late 2021, anticipating the Fed stepping away from being in the market buying this June.

The 10 Year US Treasury yield chart shows the rise in interest rates in 2013 during what has been referred to as the first “Taper Tantrum. As you can see interest rates rose throughout 2013 and actually peaked near the time in late December when the Fed stopped buying bonds and began its tapering. Once the Fed stopped purchasing, long-term interest rates actually declined throughout 2014 and roundtripped all the way back to where they were when the idea of tapering was first floated in the markets by then Chair Ben Berneke.

That’s the history of QT. The Fed steadily reduced monthly bond purchases throughout 2014, winding them down entirely in late October. Yet 10-year yields fell during this time and kept falling after QT was finished in late 2014.

In other words, the markets anticipated tapering, long term rates rose by about 1.25%, but once tapering began, interest rates fell by almost the same 1.25% over the next 12 to 15 months. We have overlaid the recent selloff in Treasury markets and the rise in interest rates that has happened since last November when Chairman Powell first discussed tapering. We have overlaid this onto the time frame of the previous 2013 “Taper Tantrum.”

As one can see, what happened back in 2013 is currently repeating itself in the bond markets. So far, it’s a very tight fit. With much of the real-time data now saying that the pace of inflation has peaked, and is likely to fall in the second half of the year, it would be pretty easy to say that history is likely to repeat itself in the second half and interest rates are likely to head back lower much the way they did when the Fed actually began implementing QT the first time in 2013 and 2014.

As for volatility, back then, bond volatility peaked and declined steadily for about a year. This lower bond volatility and the Move index bled over to stock market volatility which also bled lower once QT began. No, it wasn’t a straight line. But overall, the trend in volatility was down not up.

As for what groups you should have been invested in during the last tapering.

What is your best guess of what stocks and what groups performed best in the market? What sectors and what industries outperformed? Most people would Probably guess Boring. Stable? High dividend? Low growth stocks, yes? Those probably were the best stocks during QT, don’t you think?

Nope, those were the exact worse groups back then. Yes, back then, post taper tantrum in 2013, and during the actual taper, what were the best groups? Exactly the opposite that most investors were positioning and expectating. High growth Nasdaq 100 stocks soared. Cyclical industrial stocks and small cap stocks were next in line followed by consumer discretionary, tech stocks and cyclical material names. Ex materials, all of these groups have been big laggards’ this year as they were the winners in 2020 and mid-2021.

The worst groups in the last taper time? They were energy, utilities, and staples stocks. Yes, largely boring, slow growth, stable and high dividend names. Exactly opposite to what one would have expected. Here’s a summary provided by CFRA of the winners and losers during the first period of tapering.

As you can see, the 2013 taper tantrum, with all its sound and fury didn’t amount to much when it came to pressuring the markets and more specifically growth and cyclical oriented equities. Will history repeat in the second half of 2022 through 2023, mimicking the first taper timeline? No one knows for sure, and past performance is no guarantee of future results, but we do know as investors that markets and time periods tend to frequently rhyme. Why? Because investor behaviors and emotions tend to be very repeatable, fluctuating between the extremes of both fear and greed often over very short-term time periods.

Our team here at Oak Harvest knows that the last 5 months has been a trying time for those in the equity markets. The sustained higher market volatility for the first time in over two years is a harsh reminder to investors that stocks do not always go up. And They certainly do not go up in a straight line with low volatility. And no, there are no guarantees in the public equity markets. We know these sharp market moves tend to create emotional angst and the urge to make changes to what are supposed to be longer-term asset allocations.

If the ongoing market volatility is making you feel uneasy, I would ask you to give us a call and schedule a meeting with an Oak Harvest advisor. Our team does have insurance-based tools in our planning toolbox that do not have the volatility of public equities. However, I remind you, that these investments will also have lower expected long-term returns for your savings.

Give our team a call before making any dramatic changes to your allocation during times of heightened market volatility. These types of long-term asset allocation changes are usually best done when markets are calmer, and one’s emotions are less elevated.

At Oak Harvest, we think our clients are best served by us helping them plan for their future needs, instead of focusing on the past. The future is always uncertain and that is why our advisors and retirement planning teams plan for your retirement needs first, and your greed’s second.

Give us a call to speak to an advisor and let us help you craft a financial plan that helps you meet your retirement goals. Call us here at (877) 896-0040, and schedule an advisor consultation. We are here to help you on your financial journey into and through your retirement years.

I’m Chris Perras, and from everyone here at Oak Harvest Financial Group, have a blessed weekend.