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CONTRIBUTORS

Chris Galipeau

Senior Market Strategist
Franklin Templeton Institute

Lukasz Kalwak, CFA

Market Strategist
Franklin Templeton Institute

Key takeaways:

  • By using history as a guide, we found that equity market behavior after the US Federal Reserve (Fed) starts cutting rates varies depending on economic conditions.
  • The equity market has rallied when the Fed cut rates during expansions, with minimal drawdown risk in the year following the first cut.
  • In the years after 1990, growth and small-cap stocks have been market leaders.
     

When the Fed has cut rates during an expansion, history indicates both the equity and Treasury markets have the potential to perform well.

Financial markets seem certain that the Fed’s first interest-rate cut of its next easing cycle will be in September, with a second cut also likely in December.  Markets had expected as many as seven cuts this year, but the Fed instead held rates steady as inflation remained uncomfortably high.

With the S&P 500 Index hovering near record levels, how will stocks react to the first rate cut? Will investors become even more bullish, viewing the cut as a measure to help prolong the economic expansion? Or will they become bearish and interpret the cut as a sign that the economy is slowing?

In this paper, we answer these questions and turn to history as a guide.

WHAT ARE THE RISKS?

All investments involve risks, including possible loss of principal.

The allocation of assets among different strategies, asset classes and investments may not prove beneficial or produce the desired results.

Equity securities are subject to price fluctuation and possible loss of principal.

Fixed income securities involve interest rate, credit, inflation and reinvestment risks, and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

Large-capitalization companies may fall out of favor with investors based on market and economic conditions.

Small- and mid-cap stocks involve greater risks and volatility than large-cap stocks.

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