Which Stocks Will Get Thrown Out Of The Stroller In The Next “Taper Tantrum”?

Which Stocks Will Get Thrown Out Of The Stroller In The Next “Taper Tantrum”?
Carl Hazeley

over 2 years ago3 mins

  • Economists are expecting the Fed to hint at slowing down its asset purchases next month, before actually doing so in early 2022.

  • Investors, and therefore markets, have historically responded to the hints rather than the actual event, so it pays to set up your portfolio now rather than wait.

  • High-dividend paying stocks and those with strong balance sheets are likely to respond best to a Fed tapering announcement in the long run.

Economists are expecting the Fed to hint at slowing down its asset purchases next month, before actually doing so in early 2022.

Investors, and therefore markets, have historically responded to the hints rather than the actual event, so it pays to set up your portfolio now rather than wait.

High-dividend paying stocks and those with strong balance sheets are likely to respond best to a Fed tapering announcement in the long run.

Mentioned in story

Economists are on tenterhooks: the Federal Reserve (the Fed) is expected to hint at reducing its $120 billion-a-month asset purchases in September, formally announce it in December, and actually follow through in early 2022. And since investors have been known to throw a “taper tantrum” at the slightest whisper of a policy change, it pays to know which stocks will get thrown out of the stroller – and which ones won’t.

What happened last time there was a taper?

When the Fed last signaled back in 2013 that it was looking to slow down its bond-buying, the S&P 500 dropped 5% in total, with growth companies coming off the worst and defensive firms only slightly better off.

Performance before, during, and after the 2013 “taper tantrum”. Source: FactSet, Goldman Sachs
Performance before, during, and after the 2013 “taper tantrum”. Source: FactSet, Goldman Sachs

The simple explanation is that investors were worried economic support was ending too early, and that interest rate hikes would therefore be coming sooner than expected. It stands to reason, then, that investors sold off growth stocks – whose long-term earnings growth becomes less valuable (relative to other assets) as interest rates get higher – the most.

Still, the selloff was ultimately temporary: the S&P 500 recouped its losses in the two months after, and growth stocks actually ended up outperforming.

What will trigger the next taper tantrum?

Much like in 2013, investors are more likely to respond to the signal about what’s to come than the event itself. As for how dramatically they’ll respond, that depends on three factors:

1. How much the Fed is (or isn’t) buying

The more assets the Fed buys, the lower the “risk premium” – that is, the extra return investors demand for holding risky assets like stocks. The opposite is true too: the risk premium rises as the Fed reduces – and eventually starts selling – the assets it buys, since stocks have (all else equal) become riskier investments. That usually sends stocks down.

2. How quickly the Fed is (or isn’t) buying

If you look at S&P 500’s 3-month returns over history, you’ll see that the pace at which the Fed’s balance sheet grows or shrinks is a strong indicator of stock market returns.

3. The economic growth outlook

Most importantly, any fall in share prices should be more modest when the outlook is positive – like it is now – than when it’s negative. In fact, while it pays to look at the Fed, the growth outlook is probably the single most important factor in determining stock market returns on the back of any of its actions.

So what’s the opportunity here?

There are two of them, as it happens.

History shows that when the Fed slows the speed at which it's buying assets (which is what investors are expecting it to hint at in the coming months), stocks with high dividend yields perform best.

And when the Fed eventually gets round to selling more than it buys (a way off, but investors will start thinking about it sooner rather than later), “high-quality” companies – those that aren’t volatile and have strong balance sheets – fare best.

Investment factors’ historical response to Fed balance sheet changes
Investment factors’ historical response to Fed balance sheet changes

So I’d take a two-pronged approach:

First, buy stocks with high dividend yields. Sure, those high yields might reflect investor pessimism (since a high yield’s either the result of high dividends or a low share price), but they should perform well when the Fed hints at future tapering. This list of 20 large cap US stocks with a more than 5% dividend yield is a good place to start.

Source: Finviz
Source: Finviz

Second, buy stocks with strong balance sheets. Growth stocks often fit the bill, which means you’d risk being hit in the near term by a selloff after the Fed hints at a taper. But just like in 2013, I’d expect those stocks to bounce back quickly and go on to outperform in the long run.

Stocks in the healthcare, information technology, communication services, and consumer discretionary industries are all a good bet: some of the biggest names include Amazon, Alphabet, Facebook, Tesla, Home Depot, Nvidia, and Mastercard.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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