“Be yourself. No one can say you’re doing it wrong.” -Charlie Brown
The big story last week was the Federal Reserve Bank (Fed) cutting interest rates for the first time since March 2020. Sonu Varghese, VP Global Macro Strategist, discussed some of the reasons stocks soared after the Fed cut rates, but today I’ll look more at how stocks and various asset classes do after cuts.
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Here are six things to know about rate cuts.
Why Are They Cutting?
First things first, why are they cutting? If they were cutting due to a panic (think March 2020) or due to a recession (like in 2001 or 2007), potential trouble could indeed be lurking. But as we’ve been discussing all year, we do not see a recession coming and with inflation back to manageable levels, there was simply no reason to have interest rates up over 5%. This is what we call a normalization cut, which historically has led to continued higher prices.
Here’s a table we put together earlier this year that shows a year after the first cut in a cycle, stocks were higher a year later eight out of 10 times and up a solid 8.0% on average. Yes, 2001 and 2007 are in there, which you’ve probably heard about many times the past week if you’ve watched financial media at all. But we think now is more like the normalization cuts we saw in 1984, 1989, 1995, and even 2019, all of which saw continued gains a year later.
Historically, What Do Sectors Do After the First Cut?
Using data from BofA’s US Equity and Quant Strategy team we see that healthcare has tended to lag a year after the first cut, while areas like tech, materials, and real estate have led.
What About Various Asset Classes?
Nice chart from Bloomberg here that shows what various other asset classes do historically after the first cut.
Yes, Cuts Near All-Time Highs Are Common
Are rate cuts near all-time highs (ATH) normal? It turns out they are and the last time we saw this was in 2019. We found 20 times the Fed cut interest rates within 2% of new all-time highs and wouldn’t you know it, a year later stocks were higher all 20 times. There’s an old saying not to fight the Fed and this is what they mean.
The S&P 500 jumped 1.7% on Thursday after the rate cut, so this might be early, but it is most definitely off to a nice start. Matching the 13.9% gain on average a year later would be something we think most investors would be quite happy with right now.
Here’s a nice chart showing all the data.
Big Gains Going Into a Cut Is Quite Bullish
The S&P 500 gained more than 25% the 12 months prior to last week’s cut. One might think that big gains like that could mean some mean reversion, but that isn’t the case. Our friends at Bespoke Investment Group did this great study that showed that if the S&P 500 added more than 25% the 12 months before a first cut, it historically added nearly another 20% the next 12 months and has been higher 10 out of 10 times. 💪
Small Caps Tend to Outperform Once the Cutting Starts
Here’s another great one the team at BofA, this time showing that small caps tend to do quite well relative to large caps that first year after the first rate cut. We’ve been overweight small and midcaps most of this year and one reason we’ve been in that camp was we expected rate cuts to be a tailwind for these areas. Similar to Lucy pulling away the football on Charlie Brown, we’ve seen small cap outperformance for stretches many times, only to have the football pulled away. Well, with cuts now here and more on the way, we think ol’ Charlie Brown is about to kick the longest field goal of his life.
Lastly, I joined Jon Fortt on CNBC’s Closing Bell Overtime last week to discuss many of these concepts. Thanks for reading!
For more content by Ryan Detrick, Chief Market Strategist click here.
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