Was that a taper tantrum part deux on Friday or was it part trois? Sure felt that way. The near 400-point drop in the Dow on Friday, September 9—the tantrum—seemed an uncanny repeat of 2013 when the market dropped sharply after the Fed signaled its intention to raise interest rates—the taper.
With the weak economic data and the Fed still incessantly debating a September rate hike, and both the European Central Bank (ECB) and Bank of Japan (BOJ) disappointing on the monetary stimulus front, all markets declined on Friday. Stocks were down, bonds were down, commodities were down—everything was down—just like the circumstances that led to the taper tantrum in 2013. That, too, happened after a record period of low volatility.
What it may mean
For long-term investors focused on asset allocation, the key question at hand is: Will this turn toward higher yields, lower valuation, and tighter financial conditions be the start of a major trend, or is it like every other episode of the past few years, i.e., a temporary contracyclical mean reversion against the prevailing trend toward lower yields and ongoing stock market levitation?
I think it is the latter. There is no question in my mind that the Fed and other central banks remain in “do no harm” mode and that they will either keep easing (in the case of the ECB and BOJ) or refrain from tightening (in the case of the Fed) if the markets aren’t completely on board with a regime shift toward higher real rates.
With debt levels high and demographics and productivity growth where they are, I don’t think such a regime shift is in the cards—not yet. In my view, the Fed has learned its lesson with regard to the risks of imposing a policy error on the markets. It did so a year ago, then again in March, and then again in June. It’s a familiar dance and it usually ends the same way.
Meanwhile, on Friday, the S&P 500 closed at 2,128, right at its former breakout point. Markets that break out of large trading ranges (as the S&P 500 did) often test what has now become support. Therefore, this will be an important test. And it’s mid-September, which is seasonally the weakest part of the year.
Therefore, we have a market that I think is correcting lower, based on an assumption that the Fed will tighten when it shouldn’t, and is retesting its previous breakout point during the time of year when corrections typically happen.
Of course, each investor needs to understand his or her risk tolerance and time horizon. But if you are in it for the long term, I would consider using this pullback to review your investments and rebalance your portfolio as appropriate. Corrections may be scary, but they are also opportunities.
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