What Do Fed Rate Cuts Mean for Investors? with Mark Biller

Oct 15, 2024

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You’ve heard the saying, “Past performance is no guarantee of future results.” Does that apply to Federal Reserve policy?

The Fed is finally cutting interest rates for the first time in four years. What does this mean for investors? You might be surprised. Mark Biller has the details.

Mark Biller is Executive Editor and Senior Portfolio Manager at Sound Mind Investing, an underwriter of Faith & Finance.

The Guiding Principle: Don’t Fight the Fed

In mid-September, the Federal Reserve surprised many investors by cutting the funds rate by half a percent. While many might view this as a positive signal, it’s essential to understand that rate cuts don’t always lead to stock market gains.

A phrase often heard in the investment world is, “Don’t fight the Fed.” This principle has guided investors for decades, suggesting that investors should be cautious when the Federal Reserve raises rates and optimistic when it cuts rates. This belief has only grown stronger in recent years as the Fed has regularly intervened in the market. Historically, those who didn’t “fight the Fed” tended to fare well.

However, while this strategy has worked for the last 15 years, it hasn’t always held true, especially during certain economic downturns. Investors should remain cautious in assuming rate cuts always lead to market gains.

Rate Cuts Don’t Always Lead to Stock Market Gains

While rate cuts have often been associated with bullish markets, history tells a more complex story. For example, in both 2001 and 2007, the Fed began cutting rates just as the economy entered significant recessions. These recessions led to massive losses for investors, with the S&P 500 dropping by as much as 50%.

As economic data in the U.S. slows, some investors are beginning to wonder if we’re on a similar path to what happened in those earlier years. Could this be a repeat of 2001 or 2007, where rate cuts fail to prevent significant losses?

The Two Paths Following Rate Cuts: Recession or Non-Recession?

The key factor to understand when the Fed starts cutting rates is whether the economy is headed toward a recession or not. Historically, there have been two distinct paths that the market takes after the first rate cut in a cycle:

The Recession Path: When the economy is in or heading toward a recession, rate cuts have not helped the stock market. Since 1980, three rate-cutting cycles have occurred during recessionary periods—in 1980, 2001, and 2007. During these times, the S&P 500 fell significantly, with declines of 16.5%, 28%, and 24%, respectively, in the 12 months following the first rate cut.
The Non-Recession Path: On the other hand, when the economy avoids recession, rate cuts have given investors the boost they expected. In 1987, 1989, and 1995, the market saw gains of 24%, 14%, and 22% in the year following the initial rate cut.

The key takeaway here is that recessions are the big variable. Whether the market moves up or down after rate cuts depends largely on whether the economy is heading into a recession.

Are We on the Recession Path?

This is the question on every investor’s mind. While economic growth has been slowing in recent months, it’s important to differentiate between a slowing economy and an actual recession. Over the past few years, many have predicted a recession as the year comes to an end, yet the economy has remained resilient.

One possible explanation is that the slowing data reflects a normalization following the economic spike after the COVID-19 pandemic. Slowing growth doesn’t necessarily mean the economy is headed for a downturn. Investors have seen similar predictions in recent years that never materialized.

Looking ahead, the data suggests that the economy may still be in good shape. While there may be fears of a recession, it’s possible that those fears could once again give way to continued economic stability and potential market gains.

Why Did the Fed Cut Rates Aggressively?

The recent half-percent rate cut by the Fed was larger than many expected. Typically, the Fed only makes cuts of this size during a crisis, yet the U.S. economy is growing at 3%, with unemployment at 4.2% and asset prices near all-time highs.

This aggressive move signals that the Fed’s primary focus has shifted from controlling inflation to supporting employment and the broader economy. With inflation under control, the Fed likely sees less need for high interest rates and more risk in potentially slowing the economy by keeping rates elevated.

There’s also a possibility that the Fed made a larger cut now to avoid making multiple smaller cuts in the future. However, cutting rates too aggressively could bring back inflation if the economy continues to grow.

What Should Investors Do?

At this point, it seems more probable that we’re on the non-recessionary path, at least for the remainder of the year. The data doesn’t yet support a recession, and economic indicators like growth, inflation, corporate profits, and household net worth remain strong.

For investors, the message is clear: stay data-dependent. Watch the economic data closely, but don’t assume that rate cuts will always lead to market gains or that a recession is imminent. There’s reason for optimism, but as always, be prepared to adjust your strategy if the data starts to signal a different outcome.

While rate cuts can provide a tailwind for the market, they don’t always guarantee gains. Monitor the economic data and stay prepared for either outcome.

You can read Mark’s full article, “The Fed Is Cutting Interest Rates: What Does it Mean for Investors?” at SoundMindInvesting.org.

On Today’s Program, Rob Answers Listener Questions:

I have $80,000 in CDs with my sister as a joint owner. My sister and her husband are concerned that if I get sued, they could go after the CDs and my sister's own investments since she's a co-owner. I can remove her as co-owner, but that would mean losing $2,000 in interest. Should I be concerned about my sister's investments being at risk? Is it worth losing the $2,000 to remove her as co-owner?

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