What does Fed tampering do and how does it affect the stock market and tech stocks?

Fed tapering means that Fed reduces the amount of asset purchases. This means less money in the economy and will impact the stock market in various ways.

​

1) tapering could lead to higher interest rates, leading to lower valuations of companies.

The risk free interest rate is a component of the weighted average cost of capital (WACC) that is used in a discounted cash flow model. Thus, a higher risk free rate will increase the rate at which future cash flows are discounted by (ie future cash flows are worth less), decreasing the value of the firms.

2) signifies period of higher than expected inflation, which is historically not a good time for stocks

This is because raising interest rates is used to curb excessive inflation. The tapering could signal the fed's expectations of higher inflation to come. This will drive up the cost of inputs of businesses, decreasing income margins. Unless the firm is able to pass on the increased costs to consumers, its bottom line will be affected, leading to lower valuations

​

While both outcomes may seen negative for stock prices, I do not believe that a crash will occur due to tapering. The negative impacts, however, can be observed by the recent dip in the market when the fed warned that tapering could start at the end of this year. However, I would see this as a buying opportunity as valuations come down to more reasonable levels.

​

As for tech companies, their valuations could be more negatively impacted by rising interest rates. This is because they are mostly GROWTH companies and their expected cash flows are much further out in the future. This means a greater discount rate will have a more significant impact on their cash flows than a stable blue-chip. That being said, risk free rate is not the most important factor when picking a business to invest in and i'd much rather focus on other factors such as the business model of a firm. This is because risk free rates will impact all firms and is something well out of our control. The best we can do is pick companies with solid foundations that can survive no matter what the future holds.

​

hope this answers your question!

Tapering is done when FED thinks that there is no need of an extra liquidity boost for the economy. Mainly they look at CPI data and unemloyment data to make the decision.
Similar to QE, its a signaling mechanism to markets. Since we are in a prolonged disinflationary enviorment, lack of liquidity going forward means lack of future growth (that is the market sentiment because markets are looking forward). Long end of the curve will fall. Mega cap tech will do well because low yields have low impact on their discounted future profits.
2013 taper tantrum is a fed communication error and markets got shaken out.Tapering effects are not serious as interest rates hikes. But reducing risk or overweighting asstes for low growth regime is more sensible.

​