This Day On The Street
Continue to site right-arrow
ADVERTISEMENT
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Are The Market's 'taper Tantrums' Justified?





Though the stock market continued to roll along in July, some of its most troubled days in recent months have occurred as a reaction to signs that the Federal Reserve might start to taper its stimulus measures. Pundits have dubbed these negative reactions from the stock market as "taper tantrums." The question is, are these tantrums justified?

A looked at how the stock market has performed during several Fed policy environments suggests that the taper tantrums might be an overreaction -- unless the Fed goes too far in reversing its low interest rate policies.

Why the taper tantrums?

Why is the stock market so sensitive to interest rates? Interest rates are widely used as a discounting mechanism for valuing stocks. The higher interest rates are, the less valuable the future earnings of a stock are, because an investor would be sacrificing that higher rate of interest by investing in stocks.

The sensitivity to Fed policy is heightened now because not only have they driven short-term interest rates down to nearly zero, but they have also taken the extraordinary measures of buying Treasury and mortgage-backed securities to drive long-term interest rates down. Any tapering of these stimulus measures is likely to result in higher interest rates across the board. Indeed, just the discussion of tapering has driven Treasury yields higher.

However, despite the role of interest rates in stock valuation, the outlook is not quite as simple as saying that if rates rise, stocks will struggle. In many cases, rates rise during a period of economic strength, when rising stock earnings can offset the rise in interest rates. In other words, stocks can withstand rising interest rates, if the economy is sufficiently strong and rates don't rise too fast.

What history says about it

The Federal Reserve provides history of the federal funds rate back to the mid-1950s. Comparing changes in the federal funds rate to concurrent price changes in the S&P 500 shows that what stocks really like is neither rising nor falling interest rates, but stability. In fact, the picture is surprisingly symmetrical:

12-month change in federal funds rate

Concurrent S&P 500 price change

Large increase (2 percent or more)

+ 3.51 percent

Small increase (1 percent to 1.99 percent)

+ 7.60 percent

Roughly flat (increase or decrease of less than 1 percent)

+ 11.15 percent

Small decrease (1 percent to 1.99 percent)

+ 7.34 percent

Large decrease (2 percent or more)

+ 3.40 percent

The average 12-month price change for the S&P 500 over the entire period was 7.98 percent. So, what the chart above shows is that when interest rates change a great deal, stocks struggle. They are just slightly below average during moderate increases or decreases in rates, and stocks thrive when interest rates are reasonably stable. This suggests that the Fed has room to ease rates up gradually without crippling stock performance.

The inflation wild card

Why would the Fed be anything but gradual in its approach to raising interest rates? The one thing that could force its hand is inflation. The sharpest increases in the federal funds rate occurred during the high-inflation era of the 1970s and early 1980s. So, as closely as the stock market is watching the Fed these days, it should be keeping an especially wary eye on inflation.

null

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 16,732.72 +54.82 0.33%
S&P 500 1,955.36 +4.54 0.23%
NASDAQ 4,463.2870 +10.4950 0.24%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs