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What does Fed tapering mean for the stock market?

While Fed tapering may create some short-term volatility, historically, equity markets continued to move higher.

Market returns during Fed tightening

As we discuss in our accompanying piece, the Fed has begun to discuss tapering asset purchases in the coming months. Even after that change in direction, monetary policy would be far from restrictive. But how might the markets respond? A look at historical market performance during the last Fed tapering cycle may provide some insight on what to expect.

As illustrated in the chart above, the Federal Reserve began to slowly reduce its asset purchases in early 2014 and continued to taper purchases over the duration of the year. However, equity markets posted strong performance over the period, with the S&P 500 rising more than 11% for the year. The Fed’s next step — its announcement of the first Fed funds rate hike in that tightening cycle — in December 2015 prompted a bout of equity volatility. That was followed by another when the Fed stopped reinvesting proceeds and allowed for a gradual reduction in its balance sheet in late 2018. Despite those temporary setbacks, the equity bull market continued.

So why did equities continue to advance despite the withdrawal of Fed stimulus? Ultimately, corporate earnings growth fueled by continued economic expansion are the primary drivers of equity market performance regardless of adjustments to monetary policy. Other factors certainly play a role as well, perhaps most notably fluctuating valuations — the expansion or contraction of Price/Earnings multiples. Broadly speaking though, a midcycle adjustment to Fed policy may create some temporary disruption but doesn’t tend to have a lasting effect, particularly when that policy is still supportive.

The bottom line? A reduction in Fed accommodation may be a catalyst for short-term volatility, but against the backdrop of a growing economy shouldn’t alone end the equity bull market.

Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.

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