Stocks and Rate Cuts and Performance… Oh My - November 18, 2019

The Federal Reserve has cut interest rates three times this year. Following October’s meeting, the Fed signaled a shift in its stance, suggesting we won’t see another rate cut this year.

One closely followed gauge published by the CME Group currently places odds of a December rate reduction at just 1% (as of November 15).

While we may not see any more cuts this year, one may ask, “How do stocks perform in the wake of rate reductions?”

Conventional wisdom suggests that rate cuts are good for stocks. While trade tensions have impacted shares this year, continued economic growth and lower interest rates have been supportive.

But let’s review the data. How have stocks performed when the Fed has reduced its key lending rate—the fed funds rate—at least three times?

Table 1 highlights S&P 500 performance six months and 12 months after the Fed cut rates at least three times in a rate-cutting cycle.

For example, after the third rate cut in July 1985, the S&P 500 Index rose 7.1% within six months and 25.5% twelve months after the third cut.

However, rate cuts alone weren’t enough to fuel gains in equities. As evidenced by Table 1, economic performance played a big role. The 1990-91, 2001, and 2007-09 profit-killing recessions created stiff headwinds for stocks.

However, in the instances when the economy didn’t slip into a recession, the average increase in the S&P 500 amounted to a stellar 21.8% one year after the third rate cut.

That’s well above the long-term average increase of about 10% (CNBC).

Before I go on, I want to say I’m not predicting the S&P 500 Index will be up over 20% on October 31, 2020, assuming the economy doesn’t slide into a recession. Nor would I try to predict next year’s market return.

Many factors may influence market performance.

What the data suggests: rate cuts plus an expanding economy create a favorable environment for stocks, while rate cuts alone aren’t enough to overcome economic weakness.