As most of you would know, I have two boys, aged 9 and 7. They change their minds often - they want Mexican for dinner one minute, Indian the next, one minute they want to watch Chicken Run: Dawn of the Nugget, the next, it's Super Mario Brothers, today they don't want to attend Anthony's birthday party, the next day they do.
The market is like my two boys. Today we're going into recession, tomorrow we are not. Today the Fed is raising rates, the next, they're cutting rates. I don't have anything against changing one's position with new information. The issue I have is how dramatic and frequently the point of view changes. In fact, the market seems to be more confused than my two boys at times.
We all know this has been the most anticipated recession in history. Yet here we are – strong, consistent economic growth, lowest levels of unemployment in years, inflation on target, and the stock market hitting all-time highs – it’s an economic boom. Did we just have the soft landing? With inflation having come back down considerably, notwithstanding the recent higher than expected reading, and with interest rates where they are, we’re more likely to see rate cuts than rate hikes given the restrictive nature of the status quo.
If this is one of the possibilities, what happens to the stock market at the start of a US easing cycle, and over the subsequent months. Today we take a look at how this has played out over the last 70 years.
The chart below shows how the stock market performs whether there is a recession or not following the first rate cut. A recession is counted if within 8 months of either side of the first rate cut.
As you can see in the table above, there is a big split in performance depending on whether a recession was associated with the easing cycle. This differential is especially pronounced in the first 10 months. On average, we see equities up +18% 12 months following the first rate cut without a recession, and +52% after 24 months. On the other side, should the economy fall into recession 8 months within the first rate cut, the stock market is down -2% in the following 6 months, up +7% 12 months following, and up +10% 24 months on.
So be wary of analysis that simply looks at the average outcome through easing cycles, as much depends on whether there is a downturn or not. A recession plus or minus a few months after the start of the easing cycle is likely to be negative for equities. However, with an easing cycle and no US downturn, there is scope for a big rally in equities if history is to be believed. Under this scenario, could the Fed ease anywhere near as much as the market currently prices in, in the face of what would be a huge loosening of financial conditions as equities move higher still?
So, there are a lot of moving parts with this potential easing cycle, and as we have seen over decades and decades of data, markets have usually not been very good at predicting future rates, let alone future rates around a turning point.
With this data, the way I see it, is that the upside far outweighs the downside for equities. Put your ego and fear aside. Make decisions using probabilities, not absolutes.