Is This What Happens When the QE Taper Starts?

With the U.S. Federal Reserve expected to discuss plans to end QE at its Sept. 17-18 policy meeting, it's time to consider what happens when the QE taper starts.

You know that members of the Fed have been hinting since June that the central bank wants to scale back on its $85 billion a month bond-buying program, the third round of what's known officially as quantitative easing.

After months of mixed signals, no one's quite sure whether the Federal Reserve Open Market Committee (FOMC) will actually start the taper process now or delay it another few months.

The dilemma the Fed faces was illustrated when August's soft jobs number caused concern that the economy - and the stock market - isn't quite ready for a QE taper.

"The Fed is under increasing pressure to taper without destroying the financial markets; this number wasn't soft enough to remove the possibility of a 'test-taper' this fall," Money Morning Chief Investment Strategist Keith Fitz-Gerald said. "Whether the taper is $10 or $10 billion doesn't matter. The markets are going to have a 'taper-tantrum.'"

Nevertheless, QE3 can't go on forever. The Fed's balance sheet already has ballooned by more than $2.5 trillion since the financial crisis erupted in late 2007.

So what happens when a QE taper starts?

If this chart tells us anything, it's that the end of QE3, whenever it actually takes place, will get a collective raspberry from the stock market.

Over the past five years, stocks have gone up whenever a Fed stimulus program was in place - QE1, QE2, Operation Twist, and currently QE3 - and dropped in the brief periods when there wasn't.

Note: Keith Fitz-Gerald says one reason for the Fed's mixed messages is that it is not truly prepared for what happens when QE3 ends. But no matter what the markets do, Keith says, there will be opportunities for investors. Watch the video.