Lance Roberts | Sep 24, 2024 11:11
Last week, the Federal Reserve made a significant move by cutting its overnight lending rate by 50 basis points. This marks the first rate cut since 2020, signaling the Fed is aggressively supporting the economy amid a backdrop of softening economic data. For investors, understanding how similar rate cuts have historically impacted markets and which sectors tend to benefit is key to navigating the months ahead.
In this post, we will explore the historical market performance following similar 50-basis-point rate cuts, highlight the best-performing sectors and market factors after such cuts, and outline three critical risks investors should be aware of heading into year-end.
A 50-basis-point rate cut, especially the first one, is an aggressive action by the Fed. The Fed historically uses such a sizable cut during economic slowdowns or rising recession risks. Here are a few notable examples:
This is just an analysis of the Federal Reserve’s most recent rate cuts. Reviewing the history of rate-cutting cycles back to 1960 reveals some interesting points. The table below shows the 3-month average of the Effective Fed Funds Rate, the total decrease during a rate-cutting cycle, and related market outcomes or events.
It is worth noting that while many analysts point to periods where the Fed cut rates and stocks initially rose over the next few months to a year, in many cases, those rate cuts preceded more significant events, as shown in the chart below.
For example, many analysts point to 1995 as a similar period to today, when the Fed initially cut rates, and the market continued to rise without realizing a recession. However, a difference between 1995 and today is the inversion of the yield curve. In 1995, the yield curve never inverted, signaling a healthy economy. As shown, the yield curve did not invert until 1998, and the Fed resumed its rate cuts with a recession following in 2000, triggering the “Dot.com” crisis.
It is not unusual for investors to see an initial positive response in the short term as they welcome the Fed’s efforts to stimulate economic growth. Furthermore, prevailing bullish sentiment and momentum continue pushing higher asset prices. As shown in the table above, the primary determinant of whether the market experiences a significant correction or not hinges on a recessionary impact.
Historically, performance over a six-month to two-year period is primarily dependent on whether the rate cut successfully stimulates the economy or if deeper economic issues persist. For example, in 2001 and 2007, the six-month performance following the rate cuts was negative due to underlying economic challenges, while in 2019, the market continued to perform well until the onset of the pandemic-related economic shutdown.
Given this background, where should investors focus their attention?
When the Federal Reserve reduces interest rates, in this case by 50 basis points, the decline in borrowing costs tends to benefit different sectors and asset classes in varying ways. While there are many options, here are five areas to start your research based on historical trends.
With that information, and given the historical performance of various sectors and market factors following rate cuts, here’s how investors might consider positioning their portfolios:
While there are potential benefits to a Fed rate cut, there are also risks:
The Federal Reserve’s 50-basis-point rate cut signals a proactive effort to support the economy amid potential risks. Historically, the S&P 500 and various sectors have responded positively to rate cuts in the short term, with large-cap stocks and bonds often leading the way. However, investors should remain cautious of risks such as the upcoming election, recession, geopolitical tensions, and the Japanese Yen that could impact market performance in the coming months.
We remain allocated to the equity markets as momentum, relative strength, and the overall trend remain bullishly biased. However, we continue to regularly implement risk management protocols, evaluate opportunities, and closely watch the incoming economic data.
While everyone is trying to guess how this turns out, history suggests exercising some caution seems prudent. For us, it is always preferable to err on the side of caution. While it is easy to reallocate cash into equities, it is much more difficult to recoup losses.
Trade accordingly.
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