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Fed Taper May Lead To Next Stock Market Correction

Published 08/27/2021, 06:29 AM
Updated 09/20/2023, 06:34 AM

This article was written exclusively for Investing.com

Stocks have pushed higher and higher, even with the prospects of the Fed tapering its asset purchases of bonds. It does not matter when the taper begins because it will happen and it could have a significant impact on stock prices. The anticipation of that event has helped strengthen the dollar, pushed yields, including on the 10-year Treasury note, higher, and even started to push equity markets in parts of the world lower.

The US markets have been on a different course, rising to record high after record high, ignoring the Fed's messages of tightening policy. Despite the equity market's denial, financial conditions have started to tighten. Typically, this has resulted in a lot of volatility, making this period particularly risky.

Financial Conditions Are Starting To Tighten

The Chicago Fed National Financial Conditions Index has a strong correlation between the risk-on-and-off moods of the S&P 500 over the years. Easing financial conditions have helped boost equity prices, while tighter conditions have led to turbulence or very sharp pullbacks. After the pandemic began, monetary policy became very accomatative, allowing for conditions to become very easy, helping to push the S&P 500 to record highs. But conditions bottomed in late June and have since reversed and are rising, climbing to -0.67 as of Aug. 25 from -0.72 on July 2.

Financial Conditions Index

A Dislike For Tighter Conditions

While this tightening is minor—and conditions are, on a relative basis, easy—it does not take much tightening for the disruption in the equity market to occur. From January 2018 until April 2018, conditions tightened from roughly -0.65 to -0.50, and the S&P 500 fell by approximately 11%. The same thing happened in September 2018 with conditions tightening from -0.61 to -0.44 in December, resulting in a drop of almost 20% in the index.

In 2013 and 2014, when the Fed ended its bond-buying program, financial conditions tightened dramatically, rising from roughly -0.75 in June 2014 to -0.27 in February of 2016. The occurrence resulted in the S&P 500 virtually going nowhere over that time, but actually, It fell by more than 5%, while also witnessing three declines of about 10%.

Leverage Is Getting Tighter

Financial Leverage Conditions Index

A subindex within the broader financial conditions index specifically looks at leverage; that indicator shows significant tightening has already occurred. The index is approaching the neutral territory and is nearing zero. It could also be why we have seen margin debt levels are beginning to fall, as borrowing on margin to buy stocks may not be as readily available, taking away a significant liquidity source for the equity market.

It isn't to say that history is about to repeat itself, it could, but one thing this data tells us is that tighter financial conditions are something the equity market does not like. If conditions tighten further from here, it is likely to disrupt the stock market's rally. Just how much volatility we see will depend on how tight those conditions get, but it could be considerable given the market's epic melt-up.

Latest comments

The floor here is made of floor.. Every 60 seconds in Africa, an hour passed.
They talked about tapering Friday and market rallied 1% - and no taper til end of year - we will see a normal correction and rage until Aug unless Biden is impeached or an attack on our soil occurs
Thank you, Michael
ABC correction patten is my favorite patten to trade
WOW. This brought the comment total. This is almost like when there is a TSLA or Trump article.
I've read this kind of articles since March, 2020. But a lot of stocks doubled, and other: + 1000 %. Yes, +1000 %. I can't believe this 'information'.
Examples: Moderna, Goog, Biomarin, Cara Therap., Wells Fargo, DDS, Marathon, Shopify, etc.
Michael Kramer is trying to put fear in the market again, you should be arrested for impersonating as a finance writer
He’s prob long personally, doesn’t trade his own advice.
I would have to agree with him. I’m certain that sometime in the next 1 to 30 years we will have a correction of between 1%and 3%. You heard it here first.
solid advice
Ooo. That's a good one. :)
Fed raising rates will ********the market, esp tech, and pretty sure it won’t be 30 yrs from now.
Great article
Bullish article
great article: point made-if you bought SPY in 2012 by 2021 you would be 4x richer.noted.
"In 2013 and 2014, when the Fed ended its bond-buying program,...."  where does report of that period say they ended the bond buying program ?
Fed is transferring all money from main street to wall street 🍺🍺🍺
So, this is a great article. However, it makes far too much sense to be associated with the current stock market.
Fed chief acknowledges higher than expected inflation as markets bounce on speech. Some more “hawkish” members of the policymaking FOMC have called for an announcement on tapering at the Fed’s September meeting and the option to raise rates in 2022 if inflation proves more persistent. The Fed’s latest projections, published in June, indicate that at least two rate increases are expected in 2023. But with almost 6 million more Americans out of work than before the pandemic struck, and Covid concerns rising again the market is now anticipating tapering to begin in December or January.
Dont dismiss what this guy has to say - he has accurately predicted 35 of the last 3 market corrections
batting .086
If you keep calling for corrections you’re always right. eventually…
 well said
Market knows it and discounted it... will hit.. 40_42000 .. till March 2022....minor correction... not ruled out...
you cannot discount things like that for long term. the impact could be another financial crisis like 2008 sooner than anyone would imagine. Wall street is a very small pawn on this chess, it is not the economy itself.
Help me if you have any friends who can give you good advice about this business
Actually I don't have a good idea about these businesses so I'm following the processing to get this business idea.
Your analysis is great, but markets never follow the logic on short term!!
Stock market correction...is out of lexicon now...thrown out of the dictionary by Fed :). Just kidding...the correction articles now all look so unbelievable no matter what the charts and fundamentals show
oh be quiet. markets are 100% priced based on one thing. what Powell says. and Powell's goal is for US equities to keep going up.
Thank you Mr. Negative
Other time other world😎
Lol this dude been saying correction since last year
Yes, finally he will also be right. #Clueless
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