Tapering, when used as a verb, means to grow gradually lean. However, the two times during the second quarter of 2013 when tapering was used as a verb by Chairman of the Federal Reserve, Ben Bernanke, investors reacted as if the definition is to destroy all investment assets.
Chairman Bernanke’s tapering remarks refer to the gradual decrease in the amount of bond buying that the Federal Reserve will be doing in the future. One of the key roles that the Federal Reserve plays is the control of how much money is in circulation in the economy. Their bond buying increases the amount of cash in circulation. These purchases facilitate the very low interest rates we have been experiencing the last several years.
Prior to suggesting that tapering would be initiated at some point in the future, he commented that the economy was showing enough signs of growth and expansion that the Federal Reserve was considering its options for decreasing the economic stimulus it creates by buying the bonds.
Despite Bernanke’s May 22, 2013, acknowledgement that the economy is growing, the investment markets responded negatively to his tapering comments. Stock prices fell, as did bond prices, resulting in higher interest rates. The market declines in stocks and bonds, as well as other asset classes, were exacerbated on June 19th. On this date, following the Federal Reserve’s Open Market Committee meeting, Bernanke mentioned the possible end of all purchases of bonds by the end of 2014 and an increase in the interest rate at which the Federal Reserve loans money to banks in 2015. The increased specificity of the timeline and the discussion of permanently ending the monetary stimulus drove all investment markets much lower despite his reaffirmation of the growing United States economy.
Unlike other times when it is harder to discern what the factors are behind the drop in the prices of stocks and bonds, in the second half of the second quarter of 2013 it was abundantly clear that concern about the end of the monetary stimulus from the Federal Reserve was the primary factor driving the price declines.
In part, due to what was perceived as a negative overreaction, on July 10th, Bernanke publicly stated that the U.S. economy will need “highly accommodative monetary policy for the foreseeable future.” This comment translates into English as “we aren't going to do any tapering of our bond purchases unless the economy continues to grow and unemployment decreases.”
On July 17th and 18th, Congress held a question-and-answer session with Bernanke at which he reiterated caution in assuming anything about future Federal Reserve actions. In fact, he stated that their bond buying program is “by no means on a present course.” Essentially he was delivering the message that the Federal Reserve is continuing to monitor multiple economic indicators and is not going to reduce their bond purchases until there are clear signals that the growth rate is sustainable and having the desired effects throughout the economy.
An interesting perspective, one which Oak Wealth Advisors respects, is that the May and June comments Bernanke made were done intentionally by the Federal Reserve to get a read on how markets will react when the tapering is eventually implemented. The premise is that they floated the idea of tapering and reducing the excess cash in the economy to see how far interest rates would jump on the expectation of less money in circulation. After letting the markets reset at new levels, they essentially retracted their comments. The results of the retractions have been that the U.S. stock markets have risen and have reached all-time highs in July while interest rates have declined from their June peaks but are still quite a bit higher than they were in early May. Maybe that is just what the Federal Reserve wanted.
So what was learned from the past several months of market volatility driven by Chairman Bernanke’s comments? First, over-reacting by selling investments because it seems like everyone else is doing it is not a great strategy. For most people, there was no change in their investment risk tolerance or cash flow needs. If your personal circumstances have not changed, at most you should make modest changes in your holdings in reaction to changes in economic data or political actions. Second, other people’s panicked actions can create opportunities for those with investment discipline and long-term strategies. The stock and bond mutual funds that Oak Wealth Advisors utilizes were able to capitalize on the volatility in the investment markets to the benefit of those who own their funds. Third, the financial markets are amazingly resilient. In the five years since the worst market decline in our lifetimes, the recession of 2007-2009, almost all markets have recaptured their losses and many have reached new highs. While it can be scary to stay invested in stocks and bonds when it seems like everyone else is selling, those with the patience and discipline to stick to their plans are usually rewarded.
Oak Wealth Advisors will continue to monitor the markets and adjust portfolios to reduce the risk of portfolio declines. By not panicking and selling when the markets were declining in June, our clients have benefited by having their stock mutual fund investments increase as the U.S. stock markets have reached new highs. By increasing the diversification of our clients’ bond holdings last year and earlier this year, when the interest rates rose in May and June, our clients lost far less value in their bond investments than if the adjustments had not been made. We certainly will not avoid every future market pitfall, but we will work to understand the economy and the markets to help us manage the risks in our clients’ portfolios. Our main goal continues to be helping our clients reach their financial goals.