Will a rate cut keep the stock market rally alive?
Author: Mike Archibald
July 19, 2019
The prospect of interest rate cuts has given equity markets a huge boost so far in 2019, but the rally to date may be the start of something even bigger if the U.S. Federal Reserve (Fed) does as expected and lowers its overnight lending rate later this month.
While some investors believe that future policy easing is already baked into stock prices, history tells a different story—one that typically involves double-digit returns in the year following the Fed’s first move in a rate-cutting cycle.
Take the track record of the Dow Jones Industrial Average, for example, after the 23 “first cuts” made by the U.S. central bank since 1921.
Recession vs. no recession: Past performance of the Dow Jones Industrial Average following the start of a new rate-cutting cycle
Not surprisingly, the Dow’s performance over these various cycles differed when the economy entered a recession compared to when it did not. When a recession was experienced, the average forward one-year return was 11%, with most of the gains coming at the end of the 12-month horizon. In non-recession cases, meanwhile, the gain was a staggering 24% with particularly strong performance in the early, post-cut months.
The S&P 500 index also performed extremely well in non-recessionary cases, led by non-resource, pro-cyclical sectors such as information technology, communications, healthcare and industrials.
Sector breakdown: S&P 500 performance in a non-recessionary environment following the start of a new rate-cutting cycle
Clearly, based on this analysis, the state of the underlying economy has the potential to play a very big role in the ongoing trajectory of stock prices once (and if) the Fed starts lowering rates.
At the moment, imminent recession seems unlikely given the U.S. economy’s solid employment picture and still positive—albeit slowing—GDP growth. But the ongoing expansion will continue to be threatened by trade tensions between the U.S. and China and other potential headwinds that may arise in time.
Either way, with the Fed set to cut, investors should not be surprised if stock markets continue to rally in the months ahead. As Mark Twain once said, “History doesn’t repeat itself, but it often rhymes.”
Mike Archibald is an associate portfolio manager at AGF Management Ltd. He is a regular contributor to AGF Perspectives.
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