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Still to come? Pain from Fed's 'taper' dismount

The stock market has gone down both times the Federal Reserve got out of the bond-buying business. Market gains have slowed since the Fed began "tapering" its third round of asset purchases in January. Will stocks plunge anew at the end of QE3?

That's what Wall Street fears.

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The Federal Reserve's experimental policy of buying long-term U.S. Treasuries and mortgage-backed bonds has been bullish for stocks since the policy was devised in late 2008 during the financial crisis. But if history repeats itself, stocks will dip again when the Fed exits the bond-buying business for good, data from Bespoke Investment Group suggest.

Traders work on the floor of the New York Stock Exchange (NYSE).
Getty Images
Traders work on the floor of the New York Stock Exchange (NYSE).

Indeed, when the Fed has been in the market buying bonds, a policy designed to keep borrowing rates low and dubbed "quantitative easing" (QE), stocks have posted double-digit percentage gains.

The Standard & Poor's 500-stock index rallied 36.4% during QE1, which ran from Nov. 25, 2008, to March 31, 2010, according to Bespoke. It rallied another 24.1% from the time then-Federal Reserve chairman Ben Bernanke hinted at QE2 in a speech in Jackson Hole, Wyo., on Aug. 27, 2010, until the end of QE2 on June 30, 2011. The benchmark index has rallied 33% since QE3 began on Sept. 13, 2012.

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But what Wall Street fears is a reprise of the stock market drops that followed the end of QE1 and QE2.

The S&P 500 fell 9.0% between QE1 and QE2. And suffered its last correction, falling 11.7%, after QE2 and before the start of Operation Twist.

The Fed is expected to end QE3 and stop buying bonds as early as October. And that has Wall Street worried.

"The fear with the taper," says Bespoke co-founder Paul Hickey, "(is) that markets (will) see a repeat of what transpired (falling stock prices) back in 2010 and 2011 when QE1 and QE2 were wound down."

While that fear hasn't materialized yet, there's no disputing the pace of the stock market's gains have slowed this year as the Fed has reduced the dollar amount of bonds it buys each month. In late July, the Fed trimmed its monthly bond purchases by $10 billion to $25 billion, down sharply from the peak of $85 billion per month at the start of the year.

Since the taper began, the S&P 500 has gained about 5%, down sharply from a nearly 30% gain last year.

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And that doesn't bode well for stocks moving forward.

"Whether (stocks losing steam) is due to the taper or not is up for debate," Hickey wrote in a report. "But if the taper bears responsibility (for) the rally's slowdown, it would bode poorly for the end of the year when the taper is fully wound down in October."

You've been forewarned.

By Adam Shell, USA Today

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