Advice for Savvy Retirement Planning

What is The Taper? Don’t Panic

Mount St. Helens** UPDATE **
12/18/2013

Well, there you have it. The Fed has finally announced it plans to being Tapering their bond buying from $85B a month down to $75B a month. Truth be told, the reduction in bond buying is symbolic, nothing more than market window dressing. In reality, it accomplishes nothing, as materially, they are still buying a whole lot of bonds. But what it does accomplish is to acknowledge that tapering has begun, and allow the market to get over its Tapering Phobia. Going forward, this allows the Fed to essentially reduced bond buying at any point, by virtually any amount, without further spooking investors.

What’s Going On?
So here we go. We’ve had QE, The Fiscal Cliff, the Debt Ceiling, and The Sequester. Now we have…The Taper. Sounds like a series of John Grisham novels. Yesterday, Fed Chairman Ben Bernanke spoke about the Fed’s views on the state of the economy and their strategy moving forward regarding slowing or eliminating of the current quantitative easing measures (QE, or buying of bonds) the Fed has been undertaking.

The major concern, and what prompted the vicious selloff in markets yesterday, which has spilled over into today, is that the Fed has been artificially propping up markets with their QE measures. While many have wanted to dismiss the bond buying process as an invalid reason for the market running up the past year or so, the actions of yesterday and today indicate otherwise.

I Don’t Get It
OK, after the credit debacle in 2008, the Federal Reserve Bank (The Fed) began a series of measures to “re-inflate” the economy. Primarily, they began buying up U.S. Treasuries and mortgage securities (known as Quantitative Easing, or “QE”). They did this in multiple “rounds” (ie. QE1, QE2, etc.). By buying these bonds, it pushes liquidity (cash) into those markets. Typically, Fed bond buying is done to lower short-term interest rates (to prompt borrowing which encourages economic activity). However, since short-term interest rates were at virtually zero, they have used the less-conventional method of buying longer-dated bonds to lower long-term interest rates (ie. mortgages).

The other affect that lowering interest rates has on markets, is that investors seeking reasonable returns have seen their interest income plummet over the past few years, which induces them to seek riskier, higher returning investments in the stock market. By doing so, simple economics plays out and stock prices (by virtue of supply/demand) are pushed higher, regardless of economic underpinnings. In a nutshell, the Fed has been artificially inducing economic activity, pushing down interest rates, and forcing investors into the stock market.

So What Just Happened?
Investors are concerned about what will happen once the Fed turns off the QE faucet. All indications are that the Fed will begin to “taper” their purchases of assets over time, as the economy continues to improve. There are some benchmarks the Fed is using to prompt this “taper” of buying, such as a lower unemployment rate (6.5%), and a target inflation rate (roughly 2.5%).

In yesterday’s speech, Bernanke indicated that the economy may be moving along a bit faster than expected, and that the tapering of bond purchases could begin later this year. This prompted a sharp selloff of stocks AND a dramatic rise in interest rates (which directly reduces the price of bonds). The interesting part about the speech was that there was really nothing new that the Fed reported. The news was essentially the same as what we have been hearing and expecting for quite some time. But with investor psychology being what it is, it appears that most people are now feeling like the recent stock market growth has run its course, and is primed for a pullback. This essentially causes a “herd” mentality in the market and investors begin to exit the markets en masse.

Should We Panic?
Much of what is going on right now is knee-jerk panic selling. Lots of institutional investors (mutual funds, high-frequency traders, etc.) are trying to sell ahead of the crowd. Having said that, I have been talking for a year now about how fragile the economy really is, that the stock market was becoming over-heated, and that a “Day of Reckoning” would come. Unfortunately, we have no idea if that day is now. And keep in mind, we also have no idea how far markets can fall once they begin falling.

What is unfortunate is that right now, quite simply, EVERY asset class is getting hammered (U.S. stocks, global stocks, bonds, gold, silver, commodities, etc.). It is one of those very rare situations where poor conditions for both stocks AND bonds are converging.

The good news for our clients is that we have been taking riskier investments off the table for quite some time, and last week reduced our risk exposure even further. This is not to say that we have no exposure to risk at this point. Portfolios are still invested, but the risk has been scaled back. We will be watching markets very closely, and will pare back our exposure even further should conditions continue to deteriorate. The last thing we want to do is sell off much of our portfolios, only to see markets reverse quickly back up (which happens quite often).

In the short-term we simply have NO way of knowing where the market will go. There are no easy “rules” to follow when looking at the short-term picture. The only rule we try to follow passionately is “don’t lose investor money”.

Rest assured that we are watching all of our portfolios and the markets very closely. Should you have any questions, please don’t hesitate to let me know.

Robert Henderson is the President of Lansdowne Wealth Management, an independent, fee-only advisory firm in Mystic, CT. His firm specializes in financial planning and investment management for retirement, with a special focus on the particular needs of women that are divorced or widowed. He is an Accredited Asset Management Specialist and a Certified Divorce Financial Analyst. Mr. Henderson can be reached at 860-245-5078 or bhenderson@lwmwealth.com. You can also view his personal finance blog, The Retirement Workshop at http://lwmwealth.com/blog and the firm’s website at http://www.lwmwealth.com.

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