What Do Fed Rate Cuts Mean for Your Stock Portfolio?

Last month, the Fed took a drastic step to cut rate twice by a total of 125 basis points. And with a drop of 225 basis points since last fall, what does this say about likely stock returns? Let’s look at the historical data.

Since 1950, the Fed cut more than 200 basis points 11 times in attempts to simulate a faltering economy. Economists believe it takes six months for the rate cuts to take effect which should last for as long as three years. Therefore I examined the one- and three-year returns of the S&P 500 Index and the Fama/French Small Cap Value benchmark portfolio for each rate-cut period.

After cuts of 200+ basis points, the average one-year return for the S&P 500 was 13.5% with two negative-return periods. The average three-year returns for the S&P 500 was 31.8% with one negative-return period.

However, the Fama/French Small Cap Value benchmark portfolio fared better. The one-year average return is 34.5% with no negative returns. The three-year average return was 100.5% with just one negative-return period.

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It’s apparent from historical data that Fed rate cuts don't guarantee making money in stocks. However, they do increase the odds of doing so— particularly with small cap value stocks. (Note: the odds of losing money with the S&P 500 index in any given year is about 30%.)

Martin Zweig once said: "Don't fight the Fed!" How wise was his counsel!

Disclosure: Author owns IWN

Comments

[Myron Shlapak]

One thing to keep in mind regarding the potentially low interest rates.

It is only good for the economy if someone is willing to lend it out.

So far just about all the money coming from the Fed is staying in the Banks, only trickles are getting out to thier best clients. High risk will not see any cash for some time.

[Michael Zhuang]

Myron,

Very good point. Kevin Walsh (Fed governor) said:" You've seen one financial crisis, you've seen one financial crisis." History may not repeat itself. One should read history with that caveat in mind.

Michael

[Lisa]

Very interesting article.