Rate cuts from the Federal Reserve are being pushed for by investors in the stock market, even though the S&P 500 has been on a record-breaking run even without them. Research from the Wells Fargo Investment Institute says investors should be careful about what they wish for because it has happened in the past.
Austin Pickle, an investment strategist analyst at WFII, said in a Monday note that investors want rates to go down because the longer rates stay high, the higher the chance that something will break and bring down the economy or market in a big way.
“However, in the past, the start of a Fed rate-cut cycle has usually been accompanied by a substantial drop in the stock market,” he wrote. “The average drop in value has been about 20% in the 250 days after the first Fed rate cut since 1974.” (Look at the chart below.)
With hopes of seeing six or even seven quarter-point rate cuts before the end of the year, investors were excited about 2024. Those hopes were dashed by inflation that was higher than expected and strong economic growth in the first quarter. Now, investors are planning for around two cuts, maybe starting in September.
Still, stocks have gone up, though most of the gains have come from megacap tech stocks. So far this year, the S&P 500 SPX is up more than 14%. Since July 26, when the Fed raised rates for the last time, the index has gone up about 20%.
As with most things that happen in the market, this shows that context is important.
Pickle pointed out that stocks had double-digit returns during four of the last five pauses after the last hike in a rate cycle, except for the 2000–2001 cycle, which was marked by the bursting of the dot-com bubble.
He said this makes sense because when the Fed is on hold, it means that conditions are good for growth that is neither too hot nor too cold and inflation that is slowing down. This is usually a good time for stocks to do well.
In the same way, when rates do go down, the market’s response will likely depend a lot on why policy is being eased.
Pickle said, “We think stocks will likely do well over the next six to eighteen months if the Fed changes policy to adjust real rates for falling inflation.” “On the other hand, we think stock prices will fall if the Fed has to cut rates quickly in response to a macro or market disruption.”
