The effect of previous Federal Reserve interest rate cuts on the S&P 500 provides a murky picture.
Federal Reserve Chair Jerome Powell has mentioned two factors that could lead to interest rate cuts. One was inflation declining to near the Fed's 2% goal. The other was a weakening job market.
Both boxes have now been checked off. The Fed's favorite inflation metric -- the personal consumption expenditures (PCE) price index -- fell to 2.5% in June. July jobs numbers were weaker than expected.
The probability of a near-term interest rate cut has risen. But will the stock market soar if the Fed cuts rates in September? Here's what history shows.
Image source: Getty Images.
Looking back
The Fed has lowered interest rates 28 times so far this century. These rate cuts came in spurts on six occasions.
In early 2001, the Fed began a series of 11 rate cuts. At first, these cuts were primarily due to the U.S. recession following the dot-com bubble burst. The terrorist attacks on Sept. 11, 2001 provided another catalyst for Fed action. How did the stock market respond? Not too well.
^SPX data by YCharts.
Although that recession ended in November 2001, the subsequent recovery wasn't very strong. The Fed stepped in with an additional rate cut in November 2002. The S&P 500 didn't respond immediately, and it even fell in the first quarter of 2003. However, the index rebounded strongly in March. The Fed cut rates by 0.25% again in June 2003. Again, stocks didn't move much immediately. However, the uptrend soon resumed.
^SPX data by YCharts.
Four years went by with no changes to interest rates. However, the housing market crash in the second half of 2007 caused the Fed to shift into gear. It lowered rates in September 2007 and then continued to cut rates another six times through April 2008. These actions weren't enough to forestall a significant drop in the S&P 500.
^SPX data by YCharts.
Then came the stock market crash of October 2008. The U.S. economy was in a decline so bad that it became known as the Great Recession. The Fed cut interest rates by 0.5% twice in October, followed by a 1% cut in December. The S&P 500 initially plunged, but bounced back beginning in March 2009.
^SPX data by YCharts
More than a decade came and went. The U.S. economy and the stock market roared back. However, in August 2019, the Fed began what Powell referred to as a "mid-cycle adjustment." It lowered rates by 0.25% three times, with the last cut on Oct. 31, 2019. The initial cut didn't seem to cause any stock market reaction. However, the S&P 500 took off after the Fed's October move.
^SPX data by YCharts.
The COVID-19 pandemic spurred the Fed to cut rates twice in March 2020. Although the S&P 500 still plummeted at first, it quickly rebounded.
^SPX data by YCharts.
Why the mixed results?
As we've seen, there have been mixed results in the stock market when the Fed has cut rates in the past. Why didn't the S&P 500 always jump on what should have been viewed as good news by investors? It's complicated.
In some cases, the Fed's moves simply weren't enough to immediately offset severe economic or geopolitical challenges. For example, rate cuts weren't enough to calm investors after the 9/11 attacks or the stock market crash in 2008.
Other times, investors could have decided to wait and see if the interest rate cuts would make a big enough difference to warrant more optimism.
Also, the Fed often telegraphs its moves well in advance. When investors anticipate rate cuts, they can begin buying before they occur. The actual rate cuts could then become practically a non-event for the stock market.
Good investing ideas if a rate cut is on the way
The history lesson here is straightforward: Don't bet on stocks soaring solely because the Fed cuts rates. They might, but they might not. However, I think there are some good investing ideas if a rate cut is indeed on the way (whether in September or in subsequent months).
Long-term bonds usually increase when interest rates fall. The Vanguard Long-Term Bond ETF (BLV 0.59%) is a smart way to play this trend. This exchange-traded fund (ETF) owns nearly 3,100 long-term bonds and has a low annual expense ratio of 0.04%.
I also like the Vanguard Small Cap Value ETF (VBR -0.89%). Small-cap stocks often rise when rates are cut. Smaller companies frequently have a higher percentage of debt than larger companies do. Lower rates reduce their interest expenses.
Keith Speights has positions in Vanguard Small-Cap Value ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
FAQs
As a general rule of thumb, when the Federal Reserve cuts interest rates, it causes the stock market to go up; when the Federal Reserve raises interest rates, it causes the stock market to go down.
Why is September historically a bad month for the stock market? ›
The September Effect is a worldwide phenomenon; it doesn't only affect U.S. markets. Some analysts consider the negative market effect may be attributable to seasonal behavioral bias as investors make portfolio changes to cash in at summer's end.
What stocks do well when interest rates fall? ›
For example, stocks of utility and home-improvement companies tend to perform better when interest rates fall, she said. Asset categories like real estate investment trusts, preferred stock and small-cap stocks also tend to do well in such an environment, Jenkin said.
Which stocks will benefit from rate cuts? ›
Given these factors, Indian sectors that might benefit from a Fed rate cut are IT, BFSI, auto, and realty. Overall, the rate cuts will be welcomed positively by the Indian market because the RBI is following the US Federal Reserve's lead when it comes to interest rates.
What month do stocks drop the most? ›
September is traditionally thought to be a down month. The September effect highlights historically weak returns during the ninth month of the year, which could be aided by institutional investors wrapping up their third-quarter positions.
What is the most common month for stock market crashes? ›
October Crashes
September, not October, has more historical down markets. However, October also has had its fair share of record stock market crashes. Some of the events over the decades that have given October the reputation for stock losses include: The Panic of 1907.
What is the best month to invest in the stock market? ›
When thinking about the best months to buy stocks, examining historic performance can be helpful. Data showing average monthly returns for the S&P 500 between 1950 and 2023 shows that broadly, November, July, April, and October tend to be the best months to buy.
What to buy before rate cuts? ›
With aggressive rate cuts on the cards, it's a good time for some portfolio readjustment to consider stocks to buy that will benefit from expansionary policies. An obvious choice is gold mining stocks with the precious metal likely to trend higher on rate cuts.
Why do stocks go up when interest rates go down? ›
Lower rates make borrowing money cheaper. This encourages consumer and business spending and investment and can boost stock prices. Lower rates can also lead to inflation, which undermines the effectiveness of low rates. Higher rates discourage spending and can depress company returns and, therefore, stock prices.
Where to invest in falling interest rates? ›
Bonds are fixed income investments that pay out a set amount of interest, called a coupon. Typically, when interest rates fall lower than the rate offered by the coupon, a bond becomes a more valuable investment option because it will be offering a higher return than is available elsewhere.
Like anything else, there are always two sides to every coin—low interest rates can be both a boon and curse to those affected. In general, savers and lenders will tend to lose out while borrowers and investors benefit from low interest rates.
What is the best investment when interest rates are rising? ›
Dividend stocks
Dividend stocks should also do well in an environment where interest rates stay high because the dividend payments offer an immediate return to investors. After you receive the dividend, you can decide whether to reinvest the proceeds back into the company or find a better use for the cash.
Who benefits most from higher interest rates? ›
With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.
Do stocks go down when interest rates are high? ›
Due to the fact that higher rates slow economic activity down, raise the cost of borrowing and make government bonds and cash more attractive options as discussed, people expect stocks to fall in price.
What happens to the market when the Fed raises interest rates? ›
A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.
How does the Fed announcement affect the stock market? ›
The Announcement Effect and the Federal Reserve System
An announcement from the Federal Reserve ("the Fed") about a change in interest rates generally correlates directly to stock prices and trading activity. For example, if the Fed raises interest rates, then stock prices are liable to fall.
Where to put your cash after the Fed's interest rate increase? ›
Since savers don't know which way rates will move next, advisers often recommend a CD ladder. This means buying a series of CDs with progressively later maturity dates. Laddering ensures that some portion of your savings matures each year and can be spent or moved into other investments as rates change.
