Episode Details

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:

1. 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.
    
2. 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 nec