Last month, the Fed took a decisive step to cut the rate twice by 125 basis points. And with a fall of 225 basis points since last fall, what does that say about the likely return on stocks? Let’s look at historical data.
Since 1950, the Fed has cut 11 times by more than 200 basis points in an attempt to simulate a shaky economy. Economists believe that the reduction will take six months to take effect, which should last up to three years. So I studied the one- and three-year returns of the S&P 500 and the Fama / French Small Cap Value benchmark portfolio for each rate cut period.
After a reduction of 200+ basis points, the average annual return for the S&P 500 was 13.5% with two negative payback periods. The average three-year return for the S&P 500 was 31.8% with one negative profit period.
However, the Fama / French Small Cap Value benchmark portfolio performed better. The average yield for one year is 34.5% without negative returns. The average yield for three years was 100.5% with only one negative profit period.
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 show that lowering the Fed’s rate does not guarantee earnings on stocks. However, they increase the chances of doing so – especially with low stock prices. (Note: The probability of losing money with the S&P 500 index in any year is about 30%).
Martin Zweig once said:
Don’t fight the Fed!
How wise was his advice!