When markets have a ‘taper’ tantrum

This post was originally published in the Washington Business Journal’s WBJBizBeat Blog. | Washington Business Journal

In late May, Federal Reserve System Chairman Ben Bernanke signaled that the third round of Quantitative Easing (QE3) could start winding down by year-end. This announcement created a lot of market turmoil and quickly became known as the “taper.” Fed Chairman Bernanke laid out a plan where the Fed would slow its bond-purchasing program as the economy and the job market continues to improve.

With this announcement, the quarter saw a meltdown in bond prices and a corresponding increase in yields. The 10-year Treasury yield rose to 2.66 percent from 1.97 percent in a month. We have witnessed 30-year mortgage rates increase by over 1 percent, to 4.5 percent, which may have played a part in the disappointing housing starts number posted July 17.

U.S. corporate bonds suffered their worst quarterly performance in nearly five years, with quarterly returns in the minus-3.5 percent range. Average yields on high-grade debt jumped from 2.7 percent to 3.4 percent during the same period.

Stock markets were affected as well, especially in the emerging markets. For example, from its high on May 20, the Philippines saw its market drop 22 percent, while Latin American indices were down 16 percent for the quarter.

The Dow Jones Industrial Average dropped 600 points in two days. The S&P 500 was not immune as it dropped 5 percent from its late May highs to late June lows. The S&P posted a late-June rally when the Federal Reserve went into full damage control.

On June 24, Dallas Fed President Richard Fisher, a noted “hawk” on monetary policy, warned of feral hogs overreacting to the Fed’s plans and pushing yields to their highest levels since August 2011. Two days later, Minneapolis Fed President Narayana Kocherlakota said the reaction to the Fed’s taper talk had been outsized versus the central bank’s intentions.

In congressional testimony on July 17, Bernanke reiterated the data dependency of any moves to taper; he reiterated the benchmark rate will remain near zero for the foreseeable future as recent economic data shows slowing from six weeks earlier. This includes the recently released below-forecast June retail sales.

What should an investor do in the face of such market turmoil?

An investor should invest in long-term secular themes that will affect the world over the next decade or two. They should identify the best businesses around the world that will benefit as these themes play out.

During volatile times, this approach requires patience — an underappreciated virtue in today’s investing world.

But it will be worth the wait.


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