Don’t Fight the Fed?

When you listen to the financial media, you will hear much talk about many "macro-economic" indicators. They discuss inflation, unemployment, economic growth, interest, the yield curve, and other factors.

On any given day, they will be emphasizing different factors.

There has been much discussion recently about the jobs report. We wrote about it a week ago today and explained what it really means for the stock market.

The key thing to remember when you listen to the media discuss these factors is that they are NOT on your side. They are not trying to educate you or make you a better investor, and they certainly are not trying to make you money.

They are trying to get you engaged. Most often, that means getting you worried.

We often discuss how human beings respond eight times more to negative stimuli than to positive stimuli. The media knows this, and that is why most of the news we hear is bad.

This plays itself out in an interesting way regarding the macroeconomic indicators.

Our favorite response when someone asks us about the impact of these indicators is – “It depends.”

We are not trying to be elusive but rather acknowledging that the movement of these indicators has different meanings at different points in the economic cycle.

This brings us to today's HX Daily topic: the impact of the Federal Reserve Bank's interest rate cuts.

As we are sure most of you know, the Fed is likely to make its first rate cut in several years at its upcoming September meeting.

From a big-picture perspective, this should be a good thing.

Lower interest rates reduce the cost of interest for both consumers and businesses.

Mortgage rates, auto loan rates, and credit card rates will go down, giving consumers more cash. Business loan costs will also go down, allowing businesses to make more investments.

So, the Fed's first rate cut should be good for the stock market. Is that correct?

Not necessarily if you listen to the media!

 Recently, they have brought on many pundits who will tell you that the stock market tends to go DOWN most of the time after the first rate cut.

Here is the thing – they aren’t wrong. However, it depends.

Here is a great post from Grant Hawkridge on Twitter/X…

(By the way, you should give Grant a follow and subscribe to his newsletter. He does excellent work.)

This is a busy chart, but it has a great insight.

You can clearly see the line showing where the "First Cut" takes place. Then Grant differentiates between times when the Fed cuts rates gradually (blue) and rapidly (red).

The chart is quite clear—EVERY TIME the Fed gradually cuts rates, the stock market increases.

When they cut rates rapidly, the picture is much more mixed. Sometimes, it sends the stock market soaring, but most of the time, it drives it lower. In fact, the worst one-year performances are when they cut rates in this manner.

Why is this?

The reason is that if the Fed cuts rates rapidly, it is most often when the US economy goes into recession or some manner of crisis. Sometimes, it may be in response to an outside event (COVID), but mostly, it is done to "save" the economy.

The economy needing to be "saved" means it is in bad shape. When the economy is bad, the stock market is bad. That is a good rule.

Look at the dates on the bottom. You will see that these rapid rate cuts have only occurred in the last twenty-five years. They were in response to the collapse of the Internet Bubble, the Global Financial Crisis, and COVID-19.

Most investors know this, so they fear a rate cut, given the track record over the last quarter century.

Go back further, though, and you can see that in the previous two decades, the Fed cut rates mostly gradually. We wrote about this period earlier this year here.

We wrote about how the US economy doesn’t always need to be in crisis.

Again, most investors weren’t investing twenty-five years ago and don’t remember those times.

Here at HX Research, though, we WERE! We were running hundreds of millions of dollars in the 1990s and remember these times clearly.

Do we think this is what is going to happen THIS time with the Fed rate cuts?

It is. We think the 1990s playbook makes a ton of sense andthat—unless there is a big outside shock—we are likely to see something like this play out.

Please don't listen to the media and fall into their engagement trap.

Do the work. Learn the history. Follow the data. It will make you a better investor!