Last month, the Fed took a decisive step, cutting the rate twice by 125 basis points. And with a 225 basis point drop since last fall, what does that say about the stock’s likely return? Let’s look at the historical data.
Since 1950, the Fed has cut by more than 200 basis points 11 times in attempts to simulate a faltering economy. Economists estimate that it will take six months for the rate cuts to take effect, which should last up to three years. So I examined the one- and three-year returns of the S&P 500 and the benchmark Fama/French Small Cap Value portfolio for each period of rate cuts.
After contracting more than 200 basis points, the S&P 500’s annual average return was 13.5%, with two periods of negative returns. The S&P 500’s three-year average return was 31.8%, with one period of negative returns.
However, the benchmark Fama/French Small Cap Value portfolio fared better. The average return for one year is 34.5% with no negative returns. The average three-year return was 100.5% with only one period of negative returns.
Periods of rate cuts S&P500 S/V* S&P500 S/V*
of 200bp or more 1y ret 1y ret 3y ret 3y ret
Oct 1957 - Mar 1958 32% 64% 55% 106%
Apr 1960 - Jan 1961 11% 23% 25% 47%
Apr 1970 - Nov 1970 8% 12% 10% -1%
Jul 1974 - Oct 1974 21% 34% 25% 149%
Apr 1980 - May 1980 -19% 46% 46% 175%
Jan 1981 - Feb 1981 -14% 10% 20% 131%
Jun 1981 - Sep 1981 4% 25% 143% 141%
Apr 1982 - Jul 1982 52% 96% 78% 174%
Aug 1984 - Nov 1984 24% 31% 41% 39%
Sep 1990 - Mar 1991 8% 29% 19% 89%
Sep 2000 - May 2001 -15% 19% -11% 57%
Average 13.5% 35.4% 31.8% 100.5%
*S/V = Fama/French Small Cap Value benchmark Portfolio
Data sources: Federal Reserve, Kenneth French data library
Historical data shows that Fed rate cuts do not guarantee earnings in stocks. However, they do increase the chances of doing so – especially with a small share price. (Note: The S&P 500 has about a 30% chance of losing money in any given year.)
Martin Zweig once said:
Don’t fight the Fed!
How wise his advice was!