Following the playbook on tapering

As some of the most ardent Fed watchers try to bob and weave in re-sponse to any hint…

As some of the most ardent Fed watchers try to bob and weave in re-sponse to any hint that the five-year quantitative-easing program might start winding down, at least one financial adviser plans to simply follow the “market playbook” that has been written over the past several months.

“Unfortunately, the Fed didn’t start taper-ing in September as everyone ex-pected, but now we can just recalibrate because we know at some point, we’re going to go through the same thing we went through since May, when the Fed suggested it might start tapering,” said Thomas Meyer, chief executive of Meyer Capital Group.

In essence, Mr. Meyer is underscoring the rare opportunity for financial advisers and investors to navigate a known reality that eventually the Federal Reserve’s board of governors will start reducing the $85-billion-per-month bond-buying program.

When the announcement is made, as it was in May, investors can expect a certain pattern to unfold.

One of the more dramatic examples was the yield on the closely watched 10-year Treasury, which spiked a full percentage point between the Fed’s May comments, which led the market to think tapering would begin in September, and the September announcement that tapering would not, in fact, begin.

Now that tapering appears off the table until at least March, Mr. Meyer is reallocating portfolio assets to prepare for the next announcement.

“I’m clairvoyant; I can suddenly see the future,” he said. “When tapering is announced again, it will be the same scenario, except the markets will be at slightly higher levels.”

While Mr. Meyer probably doesn’t really think he’s clairvoyant, and his full strategy actually includes relying on alternative fixed-income strategies, there is a certain genius in the idea of following the existing playbook after the next hint of Fed tapering.

NO END IN SIGHT

Keep in mind that we’re talking about an unprecedented scenario that includes a Fed balance sheet that is swelling toward $4 trillion, with no official end yet in sight.

“To taper or not might not be in the frontal lobe of Mr. Investor’s mind, but it is certainly somewhere in that mind,” said Wilmer Stith, co-manager of the Wilmington Broad Market Bond Fund.

“I do think that once we get close to tapering again, that playbook is something investors will be able to use,” he added. “It may not look as violent as it did the first time around, but certainly, if and when odds of tapering go higher, we should expect higher rates, and those areas that benefited from quantitative easing may take a pause.”

While it has been a very good year for stocks in general, with the S&P 500 up more than 25%, much can be gleaned from how several broad mutual fund categories have performed in the six months since the Fed first teased the market with the notion of tapering.

From the Fed’s May announcement through the end of October, the S&P 500 gained 6.2%, while the Barclays U.S. Aggregate Bond Index fell 1.2%. Morningstar Inc.’s world bond fund category was flat over the period, but emerging-markets-bond funds lost an average of 5.7%, intermediate-term-bond funds lost 1.5%, and municipal bond funds fell 5%.

The best-performing categories since May have been domestic and foreign small-cap funds, with average category returns of between 6% and 13.6%. The five best-performing domestic small-cap-growth funds gained between 23.7% and 25.4% over the six-month period.

Within the large-cap-growth category, which gained 9.2% during the period, the top five funds were up between 19.3% and 22%.

More than five years into a quantitative-easing program designed to help prop up the economy, it is easy to forget that a reduction of that program should be seen as a good sign for the economy.

“People need to remember that tapering indicates that the Fed is confident the economy is recovering, even though it also means less asset purchases by the Fed,” said Tanweer Akram, senior economist at ING U.S. Investment Management.

“Any hint of tapering might be looked on as favorably by investors,” he added. “So that may prompt investors to take on more risk.”