Skip to main content
Monthly Archives

October 2024

Mitch Zacks – Weekly Market Commentary: What Fed Rate Cuts Mean for the Markets and Economy

By Weekly Market Commentary

The most highly anticipated Fed meeting of the year took place on September 17-18, and with it came a 50-basis point rate cut—arguably the outcome the market hoped for. 11 of 12 Fed officials voted in favor of the cut, which lowered the benchmark Fed funds rate to a range between 4.75% and 5%. Projections released after the meeting signaled that the Fed could go further, cutting by 25 basis points at each of the next two meetings (scheduled for November and December).¹

The equity market’s response has been positive in the short term, but the financial media has not been so sure. On one hand, some pundits argue the larger rate cut is bullish because it underscores the Fed’s commitment to making a decisively dovish pivot, which should lower borrowing costs while boosting economic activity and market returns. The bears, on the other hand, argue that the Fed sees an economy in trouble, thus requiring a larger rate cut to stave off recession.

Neither camp is right, in my view.

Let’s start with the bulls. The issue I have here is one I’ve written about frequently in the past, which is the idea that there is a strong correlation between the direction of rates and the direction of stocks. In theory, rate cuts are supposed to be bullish, while rate hikes are bearish. But history doesn’t support causation or correlation between rates and stocks.

For example, if we look at every bull market from 1950 onward, it’s easy to find several instances when interest rates were rising, the economy was expanding, and the stock market was going up—all at the same time. It happened in every bull market between 1950 and 1980, and notably from 2004 to 2006 and again from 2015 to 2019. Conversely, interest rates were falling in the aftermath of the tech bubble and during the 2008 Global Financial Crisis, and stocks were falling too.

For the bears, I think there’s a case of reflexive thinking when it comes to the Fed and monetary policy. Since the Fed has historically been too late on monetary policy adjustments, bears see it as likely—or even near certain—that Fed officials have also missed the mark in this cycle.

In other words, the bulls place too much emphasis on the role that monetary policy plays on stock market returns, and the bears aren’t allowing for the possibility that the Fed can execute a soft landing.

While the bears’ critique of historical monetary policy decisions is a fair one, I view the current economic setup differently. Looking at key U.S. macroeconomic fundamentals today, this is what we see:

  • U.S. annualized GDP growth of 2.5% in 2023, with 1.4% growth in Q1 2024 and 3.0% (second estimate) in Q2 2024
  • Inflation at 2.5% (July PCE price index)
  • Unemployment rate at 4.2%
  • 10-year U.S. Treasury bond at 3.75% (as of September 20).

All things considered, these data points are quite close to where we want them to be long term. The one asterisk is the benchmark fed funds rate, which at current levels of 4.75% to 5% indicates that monetary policy is far too restrictive, in my view.

Enter current Fed policy. The 50-basis point cut seems to me to be an acknowledgment that the inflation problem is now behind us and that the Fed can now focus on moving short-term rates to a “neutral rate,” which would be significantly lower than the current 4.75% to 5%.

In previous decades, when inflation was below 2%, investment and growth were strong but rarely booming, a neutral rate of around 2.5% was the target. Looking out from today, however, with sizable government deficits, shrinking labor forces, and a shift to ‘onshoring’ manufacturing, we may see more pressures on inflation and interest rates in the years ahead. The neutral rate in this scenario may be closer to 3.5%, which implies a few more rate cuts in this cycle. Should the jobs market remain stable, and inflation remain anchored to acceptable levels—as rates continue to fall—the ‘elusive’ soft landing may be precisely what we get.

Bottom Line for Investors

I made the argument previously that rate cuts are not automatically bullish or bearish. Stocks have done well when rates are rising, and they’ve done well when rates are falling. There’s no distinct correlation.

What we know from history, however, is that the stock market does tend to perform well when rates are falling and the economy is growing. Falling rates lower borrowing costs for businesses and consumers, which can bolster investment and spending. Small-cap stocks can especially get a boost since they tend to have more floating-rate debt than their large counterparts. This relationship is only relevant in an environment where the economy is growing, which should make growth—not rates—the focal point for investors.

Sources:

  1. Wall Street Journal. September 18, 2024. https://www.wsj.com/economy/jobs/the-fed-has-significantly-improved-the-odds-of-a-soft-landing-3cbf486d?mod=djemMoneyBeat_us

​​​​​​DISCLOSURE

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research, analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources may be required to make informed investment decisions based on your individual investment objectives and suitability specifications. All expressions of opinions are subject to change without notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by other parties. Zacks Investment Management does not assume any responsibility for the accuracy or completeness of such information. Further, no third party has assumed responsibility for independently verifying the information contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor. An investor cannot invest directly in an index.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Bloomberg Global Aggregate Index is a flagship measure of global investment grade debt from twenty-four local currency markets. This multi-currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The ICE Exchange-Listed Fixed & Adjustable Rate Preferred Securities Index is a modified market capitalization weighted index composed of preferred stock and securities that are functionally equivalent to preferred stock including, but not limited to, depositary preferred securities, perpetual subordinated debt and certain securities issued by banks and other financial institutions that are eligible for capital treatment with respect to such instruments akin to that received for issuance of straight preferred stock. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The MSCI ACWI ex U.S. Index captures large and mid-cap representation across 22 of 23 Developed Markets (DM) countries (excluding the United States) and 24 Emerging Markets (EM) countries. The index covers approximately 85% of the global equity opportunity set outside the U.S. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The Russell 2000 Index is a well-known, unmanaged index of the prices of 2000 small-cap company common stocks, selected by Russell. The Russell 2000 Index assumes reinvestment of dividends but does not reflect advisory fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.

The S&P Mid Cap 400 provides investors with a benchmark for mid-sized companies. The index, which is distinct from the large-cap S&P 500, is designed to measure the performance of 400 mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment.

The S&P 500 Pure Value index is a style-concentrated index designed to track the performance of stocks that exhibit the strongest value characteristics by using a style-attractiveness-weighting scheme. An investor cannot directly invest in an index. The volatility of the benchmark may be materially different from the individual performance obtained by a specific investor.