First off, let’s define taper, the word that you may be hearing over and over in the media lately. This is referring to the Federal Reserve tapering (reducing) the current $85 million per month stimulus that they have been injecting into the economy for over a year now which is being done to try to ensure that our country doesn’t once again fall into a recession. Depending upon your political leanings, you may or may not like the idea of this government stimulus, but it is something that economists who are a whole lot smarter than me determined decades ago is the right move in times like these. So the question is, how long will the Fed continue this? Right now, the answer they are giving is “until the job market improves.” This is a subjective answer, but the job market is improving, and this morning the report on November unemployment rate showed a drop from 7.3% to 7% (it was as high as 10% in 2009), and the number of jobs added last month was over 10% greater than expected. The start date of this tapering is still unknown, but it is certainly getting closer. And since the current chairman of the Fed, Ben Bernanke, will be stepping down in January, it stands to reason that a lame duck chairman wouldn’t want to make a move like this, so my guess is that the taper won’t start until at least February.
Next, let’s talk about elasticity; not the kind that’s in your underwear, but the economic definition, which is “the degree to which consumers/producers change their demand/supply in response to price or income changes.” You may ask, “Great, Eric, but what does this have to do with tapering?” As the monetary stimulus goes down, naturally bond rates go up and that typically affects stock prices negatively. As stock prices fluctuate, especially if they go down, people tend to feel poorer and curtail spending. So, how and to what extent the tapering will affects the supply and demand of goods and consumption remains to be seen, and a rise in interest rates isn’t always negative for stock markets. The only thing that is certain is that a tapering of stimulus won’t happen overnight; instead, it will be a gradual curtailing. And, should something unforeseen shock the economy negatively, the Fed does hold the reins and would likely restart the stimulus.
So, how elastic will the economy be once the taper begins? It is very hard to say, as there are many moving parts. As always, trying to time the market and guess what will happen next is a fruitless effort, so the best thing to do is to is ensure that: 1) you have sufficient cash to weather unknown storms and 2) your long-term investment objective is still the same and follow that objective by rebalancing your account(s) when the various asset classes in your portfolios fluctuate.