On Wednesday September 18^th the US Federal Reserve lowered their benchmark interest rate by 50bps.  This was the first time the Fed has cut interest rates in four years, and while the speculation leading up to the event focused on when the Fed would cut and by how much, this note quickly looks at what has historically happened after the Fed cuts rates.

 

Red Meat for the Bears

 

The first rate cut for the Fed in 2024 was 50bps. The first cut in 2007 and 2001 were 50bps, and three months later we had The Great Financial Crises (a structural recession), and The Tech Wreck/September 11^th (a structural recession followed by an event driven recession).  

 

In Looking Beyond an Ugly 3Q 2022, we talk about structural, event driven, and cyclical recessions.  We haven’t had a cyclical recession, caused by central bankers leaving rates too high for too long, since the 1990s.  Many investors have forgotten that cyclical recessions then to shallower and shorter than event driven and structural recession. 

 

The current rate cutting expectations for this cycle suggest a cyclical recession.

 

 

Red Meat for the Bulls

 

Barring an exogenous shock to global economies, the most important factor in what happens next in markets is dependant on whether or not the rate cuts in the US are followed by a recession. If we have an easing cycle, without a recession the market tends to fly.

 

 

The dynamic is similar for when the yield curve un-inverts.  What happens to markets after the yield curve un-inverts is very dependant on if we get a recession and the type of recession. Note the difference in performance in 1980 (cyclical recession), 1982 (cyclical recession), and 1990 (event driven; Gulf War and Saving and Loan Crises) vs 2000 and 2007 in the chart below.

 

 

 

The Fed has cut rates with markets near an all-time high twenty times in the past.  The S&P500 has been higher one year later 100% of the time!

 

 

 

We’ve highlighted the 1995 analogy a few times this year.  One of the risks that we spend time thinking through is if the AI melt-up is just getting started (like 1995) or if it’s getting overdone (like 1999).  Currently the 1995 chart looks more like today’s market.

 

S&P 500 in 1995 vs 2024

 

What Works When the Fed is Cutting Rates?

 

When the Fed is cutting rates: growth tends to outperform value, smaller capitalization stocks tend to outperform larger capitalization stock, and bonds tend to outperform stocks.

S&P 500 Factor Performance When the Fed Cuts Rates

 

October vs November in Election Years

 

While September is historically the worst month of the year for the S&P500, leading to markets bottoming in October, markets hate the uncertainty created by US elections leading market to bottom in November during election years.

 

Time is the Cure for Uncertain Markets

 

The longer you stay invested the higher your chance of positive returns.

 

What’s an Investor To Do?

 

Volatile markets and a sea of conflicting data points is common in investing. As a result, we recommend that investors save and invest consistently across market cycles. With this approach, an investor will buy more securities when the market is inexpensive and fewer securities when it is expensive. Most importantly, they avoid the need to make ‘hero calls’ based on market timing.

 

We recommend a barbell strategy where high-quality companies exposed to secular themes are used to provide exposure to equity markets. The other side of the barbell is cash, actively managed fixed income and alternative investments that reduce volatility and provide ballast for portfolios. For investors in the distribution phase of their lives, the focus expands to optimizing tax efficiency of distributions.

 

Please get in touch with me for a more detailed discussion.

 

Delli (delli@cibc.com)

 

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