Stock Market Guidance Based on Fed Rate-Easing History
After a much anticipated and significant policy change, the dust has finally settled from the Federal Reserve's 0.5% rate reduction announcement on September 18th.
Historical data shows that stocks have generally performed well when the Federal Reserve has initiated a series of rate cuts. For instance, in five out of the last seven rate-cutting cycles dating back to the 1980s, the S&P 500 has shown positive one-year performance following the first rate cut in a series.
Furthermore, the only two instances where the stock market was negative a year later following a rate cut cycle coincided with economic recessions. In the graph below, the dot-com bubble and financial crisis are shown in purple.
The stock market's negative response to recessions is intuitive and considered a leading economic indicator. However, this information may not be beneficial from a risk management standpoint. By the time we receive news of a recession, the stock market has usually already adjusted for this and experienced a significant drop.
A more informative way to gauge stock market returns during Fed rate-cutting cycles may be to look at the pattern of returns before the change in Fed policy. By analyzing the Dow Jones Industrial Average (DJIA) data, which spans over a century, a pattern emerges showing an inverse relationship in returns before and after Fed rate cuts, as demonstrated in the table below:
Source: InvesTech Research Newsletter Vol24 Iss09
Considering the fact that the DJIA has increased by 35% in the 24 months leading up to September 18th rate cut, tempering optimism for outsized stock market returns over the next year may be prudent.
In summary, it's important to note that this stock market guidance isn't meant to be precise, especially over such a short period as a year. The main point of emphasis should be that outsized stock market returns leading up to a Fed rate-cutting cycle have not translated into the same average return pattern a year later.
Have questions or want to speak with our team directly? Contact us.
Robert Amato, CFP®, CIMA®
Principal
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