Taper Effect (Summer 2013)

Tapering Effecton the

S&P 500

QE Tapering

• On May 22, Fed Chairman Ben Bernanke implied that the pace of QE4, the monthly $85 billion bond buyback program, could be slowed over the course of the “next few meetings,” sending equity markets into a tailspin.

• In the nearly one month period leading up to the Bernanke’s news conference on June 19, the market lived and died on every tapering rumor.

Market Reactions• In anticipation, all ten of the S&P 500 sectors dropped.

Market Reactions• The 10-year Treasury note yield rose sharply to its highest

level in more than a year.

Market Reactions• The CBOE Volatility Index (VIX) rose to relatively high

levels.

Sector BreakdownSector 6/18 Close 5/22 Close Change % Change

Utilities $193.30 203.17 ($9.87) -4.86%

Energy $597.23 610.14 ($12.91) -2.12%

Telecommunications Services $161.38 164.79 ($3.41) -2.07%

Basic Materials $254.41 258.97 ($4.56) -1.76%

Consumer Staples $423.29 427.65 ($4.35) -1.02%

Financials $267.00 269.65 ($2.64) -0.98%

Consumer Discretionary $452.30 456.36 ($4.07) -0.89%

Health Care $566.46 570.12 ($3.67) -0.64%

Industrials $381.56 382.94 ($1.38) -0.36%

Information Technology $510.03 511.11 ($1.07) -0.21%

Sector Breakdown - Utilities

Sector Breakdown - Utilities• The utilities sector was the most negatively impacted in the

S&P 500. The sector fell 4.86%, a drop that was more than four times larger than the average drop of the other 9 sectors in the index.

• With the anticipation of QE tapering, it is likely that bond prices will drop, causing bond yields to spike. When bond yields, such as the benchmark 10-year Treasury note, rise, so do interest rates.

Sector Breakdown - Utilities

• Companies in the utilities sector fund major infrastructure projects by taking on large sums of debt and repaying their lenders over time. These debt loads require payments that depend on the current interest rate.

• This puts defensive stocks, such as those in utilities, at particular risk for decline, because higher interest rates will require larger debt payments, effectively exposing utilities to higher costs.

Sector Breakdown - Energy

Sector Breakdown - Energy

• The energy sector experienced the 2nd largest decline, dropping by 2.12%.

• The decline appears to be driven by fleeting oil demand, which can be associated with the higher rate of volatility in recent weeks.

Sector Breakdown - Telecom

Sector Breakdown - Telecom

• The telecom sector declined almost as much as the energy sector; by 2.07%.

• Like utilities, telecom is a defensive sector, subject to interest rate movements. Telecoms provide higher dividend payouts to investors when interest rates are low.

• With 10-year Treasury yields rising to their highest level in more than a year, the telecom sector begins to lose its momentum.

Sector Breakdown – Basic Materials

Sector Breakdown – Basic Materials

• Basic materials were down by 1.76%.

• This drop stems from an anticipated weaker demand for basic materials in the face of slowing home price momentum and rising mortgage rates.

• A slowdown in home price appreciation can cause homebuilders to start seeking new housing projects less aggressively.

Sector Breakdown – Consumer Staples

Sector Breakdown – Consumer Staples

• Consumer staples were down by 1.02%.

• Consumer staples, another traditionally defensive sector, is a popular source of dividend income for investors disappointed with bond yields.

• These dividends, roughly 2.7% for the sector, become less lucrative as the interest rates rise.

Sector Breakdown – Financials

Sector Breakdown – Financials

• The financial sector was by down by .98%. Relative to those of other sectors, this drop was fairly low.

• The financial sector has held up better than others due to its recovery mentality in the past five years.

• Factors such as a recent increase in forecasted earnings, higher capital levels, better risk management systems and tighter regulation have supported financial stocks amidst uncertainty.

Sector Breakdown – Consumer Discretionary

Sector Breakdown – Consumer Discretionary

• Consumer discretionary sector fell by .89%.

• The relatively low drop can be attributed to the cyclical sector’s overall strong performance in recent months; a response to a strengthening labor market and a rise in consumer confidence.

Sector Breakdown – Health Care

Sector Breakdown – Health Care

• Health care stocks fell slightly by .64%.

• As of March 2013, the sector had consecutively topped analysts’ initial earnings estimates for the past twelve quarters.

• Generally, the health care sector has been one of the more stable performers in the market the past two decades. Evidently, demand has been fairly inelastic.

Sector Breakdown – Industrials

Sector Breakdown – Industrials

• Industrials fell by .36%.

• The relatively small drop can be attributed to the sector’s surging aerospace subsector, which is not sensitive to changes in GDP and interest rates.

• The aerospace subsector, the third largest in the space, has consistently outperformed the S&P 500 index in the past five years.

Sector Breakdown – Information Technology

Sector Breakdown – Information Technology

• The tech sector dropped by a slight .21%; less than all other sectors of the S&P 500.

• The sector’s apparent resilience can be attributed to a sense of cheap valuation, stable earning streams, and growth prospects from tech stocks, such as Microsoft.