The S&P 500 and the Dow Jones Industrial Average have climbed to fresh closing highs following the US Federal Reserve’s (Fed) interest rate cut of 50 basis points (bp) last week. The Nasdaq Composite has also crept up to tackle the 18,000 level. The moves come after a winning week on Wall Street that centred around the Fed’s decision to lower interest rates by double the usual 25 bp, its first cut in four years. Despite some choppiness following the initial announcement, stocks have rallied in the days following.
Equal weighted S&P 500 over last 18 months
Source: Longview Economics
The S&P 500′s rally to record levels this month bodes well for the final quarter of the year, historical data shows. When the broad index has reached all-time highs in September, it has gone on to be positive in the fourth quarter about 90% of the time, according to data from Carson Group. The S&P 500 has risen almost 5% on average in the fourth quarter of years with a September record. The outlook is even brighter when looking just at September all-time highs during election years: the S&P 500 has a 100% positivity rate for the fourth quarter in these instances. On top of that, it sees an average gain of nearly 6% during the three-month period.
But of course, we caution that there are no guarantees on historical patterns being repeated. Such data should inform but not determine any expectations, as markets are inherently largely unpredictable – especially over the short term.
Nevertheless, with additional cuts expected in the months ahead, investors are looking to history to gauge what’s next, and since the 1980s, investments in the share market have tended to perform well in the 12 months after the Fed begins to cut rates.
That all depends, however, on how the economy fares. When growth holds up, or gets boosted by rate cuts, corporate profits tend to be strong. But if the cuts aren’t enough to stave off a recession, investments of all kinds tend to suffer sharp declines. In this current environment, we anticipate that the Fed has acted quickly enough to facilitate a market-friendly soft landing.
Source: Goldman Sachs
Many small companies get an extra benefit because they tend to have more floating-rate debt than their larger peers, meaning that rate cuts directly lower their borrowing costs. As a result, the Russell 2000 index of small and medium-size businesses has often outperformed the S&P 500 after the Fed starts cutting rates. Here in Australia, small caps have tended to fall behind the market leaders over the last couple of years, and we expect that a catch-up is due – especially once the Reserve Bank of Australia (RBA) follows the Fed with its own rate cuts (anticipated in early 2025).
The US dollar tends to weaken in a rate-cutting cycle because it becomes less attractive to foreign investors who are choosing between different currencies. They are typically seeking the highest returns on ultrasafe investments, which tend to closely track benchmark rates set by central banks. We are seeing that in the USD/AUD relationship right now, with the AUD steadily rising since the Fed decision.
That doesn’t always happen, however, because currencies can swing with world events too. The US dollar generally moves higher when investors seek safety during periods of high geopolitical risk.
Gold, often perceived as a haven and a hedge against inflation, tends to benefit from rate reductions. That is because it pays no income, which investors usually mind less when rates are lower. Gold is priced in dollars, and falling rates drag on the US currency, making gold more appealing.
Gold over last 5 years – hitting new record highs
Source: Trading Economics
As always, it pays to remain alert to risks. Here is the latest Bank of America (BoA) Global Fund Manager Survey tail risk chart:
Source: BoA GFM Survey
Global fund managers see the risk of a US recession as the biggest “tail” risk, with geopolitical conflict being the second biggest. But a recession is not expected: confidence that the global economy is heading for a soft landing is now its greatest since BoA started asking the question in May last year. It’s predicted by 79% of respondents, while 7% foresee an overheating “no landing” and only 11% expect a hard landing.
Indeed, recent economic data from the US indicates a reasonably robust economy.
The Atlanta Fed’s GDPNow tracking model raised Q3’s real GDP growth rate to 3.0% from 2.5% following the release of solid retail sales and industrial production reports for August. Leading the way was an upward revision in real consumer spending growth to a strong 3.7% from 3.5%.
US Economy Looking Robust
Source: Yardeni Research
