Timing is everything. After a nine-month pause, the Federal Reserve decided on Wednesday that the time was right to resume cutting interest rates.
The stock market has been eagerly anticipating the Federal Reserve’s rate action, and for good reason. History suggests that what the Fed has just done will be auspicious for stocks.
There are some important caveats, of course.
For one thing, President Trump and his relentless pressure on the Fed may really make this time different. The presence on the Fed board of governors of Stephen Miran, a top Trump economic adviser on temporary leave from the White House, is a remarkable development. On its face, it detracts from the Fed’s ability to make monetary policy without interference from the president, who is pressing for deeper rate cuts.
Mr. Trump is still pushing to remove Lisa Cook, another Fed governor, in a nasty legal dispute, and his criticism of Jerome H. Powell, the Fed chair, continues unabated. Unquestionably, Fed independence is under daily threat. The markets have responded calmly so far, perhaps because the central bank has been steadfast in upholding its traditional autonomy and in following long-established procedures with prudence. Mr. Powell said on Wednesday that the Fed was monitoring the data as usual and responding to indications that a weakening labor market posed a bigger risk to the economy than rising inflation did. So it was time for the Fed to cut.
But the president has managed to put a cloud over the Fed’s capacity to make difficult choices aimed at ensuring both full employment and low inflation.
All that said, the central bank’s current interest-rate moves generally conform to an encouraging pattern.
The Positive Picture
Here’s the good news: Over the past 50 years, when the Fed has started to cut rates after taking a pause of at least six months, the stock market has nearly always been captivated.
There have been bumpy rides, undoubtedly. The market often lost ground in the first weeks after the Fed resumed rate cuts. But over 12-month periods, for the most part, investors have viewed falling short-term interest rates as a signal to pile into the market and bid up shares to new highs.
There have been seven episodes since 1976 in which, after starting to lower interest rates, the Fed waited at least six months before resuming a rate-cutting cycle. In all but one of these cases, or 85.7 percent of the time, the S&P 500 rose over the following year, according Ed Clissold, chief U.S. strategist of Ned Davis Research, an independent financial research firm.
The numbers are impressive. The average 12-month S&P 500 performance, overall, was a gain of 15.5 percent, compared with 10.1 percent for all years since the start of 1976. The median, or midpoint, of all gains in the Fed rate-cutting cases was 14.5 percent.
These are the dates the Fed resumed rate-cutting after a pause, along with the actual returns for the following 251 stock trading days — roughly equivalent to one calendar year:
-
Jan. 19, 1976, a gain of 5.5 percent.
-
Nov. 22, 1976, a decline of 7.2 percent.
-
July 20, 1982, a gain of 47 percent.
-
March 7, 1986, a gain of 28.9 percent.
-
July 13, 1990, a gain of 3.5 percent.
-
Nov. 6, 2002, a gain of 14. 5 percent.
-
July 26, 2003, a gain of 16.3 percent.
A separate study by Ryan Detrick, chief market strategist at Carson Group, a platform for financial advisers, focused on Fed rate cuts when the S&P 500 was near a record high, as it is now. He found that since 1980, in every one of 22 instances, the market was higher 12 months later, with an average gain of 13.9 percent.
In short, if historical returns could be counted on to predict the future, I’d conclude that the probability of the market rising over the next year would be extremely high.
Don’t Get Too Excited
Unfortunately, the world doesn’t work that way.
As Mr. Clissold put it in an interview, “The history is fascinating but it’s complicated, and it doesn’t tell us what applies to our specific situation now.”
Interest rates are important, and Fed rate cuts that stimulate the economy — and don’t arrive too late to forestall a recession — tend to be good for the stock market.
But if the economy starts to falter and corporate earnings decline, rate cuts may be a sign of trouble to come.
At the moment, the data is mixed. Blue Chip Economic Indicators, a long-running monthly survey of economists published by Wolters Kluwer, reported this month that the experts it polled expected modest growth over the next year. “The probability of a recession in the next 12 months dipped to 38 percent, down from 40 percent in August and peaks of 47 percent in April and May,” the survey said.
There are many wild cards in that forecast.
The employment numbers from the Bureau of Labor Statistics have been revised sharply downward, and the independence of that agency has also been unmoored by the Trump administration. The labor force itself has been hit hard by the administration’s policy of deportations and immigration restrictions.
In addition, the status of U.S. tariffs, and of those of its trading partners, is in flux, with the president imposing the highest tariff rates in a generation, amid legal challenges and setbacks.
There is plenty here to worry about.
High Prices
The stock market was already red hot before the rate cut and didn’t really need more encouragement. No doubt, as the bulk of the historical data suggests, a rate cut at a market peak has usually led to further market gains. What’s more, the Fed on Wednesday indicated that policymakers anticipated further cuts this year and in 2026.
Yet I wrote recently about the risk of a market melt-up — a bout of irrational exuberance that drives prices into the stratosphere and is the opposite of a meltdown. I believe that the risk of a melt-up is rising appreciably.
Stock prices are already stretched by many measures. The CAPE ratio for the S&P 500 — an inflation-adjusted measure created by the Nobel laureate Robert J. Shiller that corrects for inflation and short-term fluctuations in corporate earnings — is also at high levels. That doesn’t mean the market will fall but it suggests that current prices are far from bargains and that returns over the next decade — if not the next year — are likely to be constrained.
Perhaps the Fed will pause again. That’s possible, if inflation flares once more. That’s not the plan, though: The Fed indicated on Wednesday that a consensus of policymakers expect further rate cuts this year and in 2026. How much further is in question. Lower rates might make sense for a weakening economy.
But adding further cuts in the middle of a stock market boom could be like pouring fuel on a fire. Especially if the markets were to conclude that the Fed is becoming increasingly likely to do the president’s bidding, the possibility of untamed inflation down the road could become a major concern.
That happened in the 1970s, when Arthur F. Burns, the Federal Reserve chair, succumbed to pressure from President Richard M. Nixon to cut interest rates in 1971 and 1972. Inflation flew off on a long, painful ride upward. As Mr. Clissold pointed out, the one negative 12-month return for the S&P 500 in the otherwise positive instances of Fed rate cuts occurred in 1976, when the monthly Consumer Price Index veered between 6.7 and 4.9 percent.
No one knows where the economy is heading, or, for that matter, what Mr. Trump’s policies will be in the next year or two.
I try to stay permanently invested in global stock and bond markets using low-cost index funds, stashing enough money in safe places to ensure that I can ride out trouble.
Another bout of high inflation, or a decline or slowing of economic growth — or both, in the form of stagflation — could easily derail the bull market in stocks.
For now, it seems the sky’s the limit. I wouldn’t bet against the stock market while the Fed is cutting interest rates. But especially in this period, it would be unwise to get too excited about it.
Jeff Sommer writes Strategies, a weekly column on markets, finance and the economy.
The post Rate Cuts After Long Pauses Have Been a Boon for Stocks appeared first on New York Times.
