How Stocks React To Fed Rate Cuts...
The Fed just slashed rates by 50 basis points. How do stocks typically react when the Fed cuts rates? Well, history gives us some clear insights. Let’s take a trip back and analyze how the stock market performed during past rate cuts, starting with the period from 1970 to 1982. While it wasn’t a full recession for that entire stretch, there were multiple recessions and some tricky market conditions to navigate.
By Paul Gabrail | Saturday, September 21, 2024
1970–1982: Rate Hikes, Cuts, and Volatility
During this period, the Fed saw three different chairmen come and go. The starting Fed funds rate was 4.25%, with GDP growth at 3.3%, unemployment at 6%, and inflation at 4.4%. The worst economic contraction during this era was in 1981, where GDP dipped 2%, and unemployment hit a staggering 10.82%.
From 1970 to 1982, rates were raised a whopping 43 times and cut 22 times. Rates initially started at 4.25% and were first cut in February 1971 to 3.75%. Over the next eight years, rates fluctuated between 20% and 3.75%.
Now, let’s look at how the S&P 500 performed during this tumultuous time. On January 2, 1970, the S&P 500 was at 90.31. By August of 1982, it reached just 102, meaning the market only gained about 12% over those 12.5 years. When adjusted for inflation, investors got hit hard.
The biggest percentage drops in the S&P 500 between 1970 and 1982 were as follows:
- 1970: High of 94, low of 68
- 1971: High of 105, low of 89
- 1972: High of 120, low of 101
You can clearly see the volatility. The market had big jumps and drops, but when you view this through a logarithmic chart, it’s flat for more than a decade. Valuations started high and ended much lower. By 1982, stock valuations hit an all-time low, with the stock market being 68% undervalued. Interestingly, if you’d invested in 1982, the next decade could have rewarded you with double-digit returns, excluding dividends. The lesson here is simple: the less you pay, the more you make.
The 1990 Recession: Savings & Loan Crisis
The early ‘90s recession was triggered by the Savings and Loan Crisis. During this period, the Fed funds rate was coming down from the high levels of the ‘80s, starting at 8.5%. GDP growth was just 1.9%, and unemployment was 5.4%. Inflation was a bit higher than ideal at 4.8%. The S&P 500, however, continued its upward trend that began in 1982.
The worst GDP contraction was similar to the previous decade, but the unemployment rate only rose to 6.3%, which isn’t terrible. Rates were cut four times, ending at 6.75% by the end of the market downturn.
Now, the S&P data for 1990 tells a different story. The market saw a 20.1% drop from a high of 368 in June to a low of 295 by year-end. Individual stocks were hit even harder, showcasing the volatility that often surpasses the overall market during these downturns.
2000–2003: The Dot-Com Bust
The tech boom of the late 1990s was a time of fast growth and soaring valuations, particularly in the NASDAQ. The Fed funds rate started at 5.75%, GDP growth was solid at 4.1%, and unemployment was near historic lows at 3.9%. However, valuations were sky-high, especially in tech stocks, and the bubble eventually burst.
From 2000 to 2003, the NASDAQ fell a staggering 83%, and the S&P 500 dropped by 50%, from a high of 1552 in 2000 to a low of 775 in 2002. It wasn’t until 2003 that we saw a true bottom, marking the start of the next bull market.
While the S&P took a big hit, the NASDAQ’s tech-heavy nature caused it to suffer even more. It’s an important reminder that markets don’t always recover quickly, and even large indices can take years to bounce back.
2007–2009: The Great Financial Crisis
This recession, triggered by the housing crisis, was one for the history books. The Fed cut rates 10 times from 4.75% in 2007 to near zero by the end of 2008. The S&P 500 hit a high of 1576 in October 2007, but by March 2009, it had plunged to 666, a 57.7% drop.
The financial crisis led to bank collapses, frozen credit markets, and mortgage lending grinding to a halt. Ben Bernanke, the Fed chairman at the time, was deeply concerned about preventing a second Great Depression. His response? An aggressive rate-cutting strategy and a massive expansion of the Fed’s balance sheet.
The recession technically ended in June 2009, but the economy was slow to recover. Yet, from the lows of March 2009, the stock market embarked on one of the most significant booms in history.
2019–2020: The COVID Crash
Fast forward to the recent past, and the COVID pandemic delivered another wild ride for markets. Fed Chair Jerome Powell cut rates from 2.25% to zero in a matter of months, trying to stabilize an economy reeling from lockdowns. GDP fell 3.5% for the year, with an astonishing 35% drop in the second quarter of 2020 alone.
Unemployment skyrocketed to 14.8%.
The S&P 500 dropped 34% over two months but rebounded quickly thanks to rate cuts and trillions in government stimulus. By the end of 2020, the market had recovered much of its losses.
The Key Takeaway
What do all these historical rate cuts teach us? The stock market tends to fall during times of economic distress, but it also presents opportunities. When markets drop, emotions run high, and it’s tempting to sell in a panic. However, history shows that the best returns often come after these steep declines.
If you buy when the market is down—whether it’s individual companies or indices—you’re paying less for future cash flow. As prices fall, you’re getting better deals on valuable assets.
For long-term investors, it’s crucial to remember that the stock market has always bounced back over time. Stay calm, be patient, and take advantage of opportunities to buy when others are selling.
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