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The Federal Reserve deciding to cut rates can be a great thing for the stock market, or a sign of trouble ahead — depending on the timing.
The first rate cut, when the economy isn't in a recession, leads to a stock market rally 100% of the time, according to data compiled by Fundstrat going back to 1971. But in the last two cycles, the Federal Reserve cuts didn't come in time, Tom Lee, Fundstrat Managing Partner and the Head of Research, said in a note to clients Wednesday.
"The last two rate cuts in 2001 and 2007 came too late, the U.S. was already in a recession," Lee said, adding that investors are "skeptical" because of it.
Lee, J.P. Morgan's former chief equity strategist, said there are two ways to measure whether or not the Fed cut benchmark interest rates too late. The first is to simply ask whether or not the U.S. economy is heading into a recession, but that is usually not certain at the time. Lee says you can also look at business cycle indicators like the Purchasing Managers Index, or PMI, which shows manufacturing, or the yield curve.
The question for investors going forward is whether the central bank changed its tune in time to prevent a recession. Investors cheered the chances or a rate cut Wednesday following testimony from Federal Reserve Chair Jerome Powell that bolstered the case for easier monetary policy in the U.S. The S&P 500 briefly broke above 3,000 for the first time, while the Nasdaq Composite and Dow Jones Industrial Average also hit all-time highs. Investors have now priced in a 100% probability of a Fed rate cut in July, according to the CME Group's FedWatch tool.
In Powell's prepared testimony to the House Financial Services Committee, he said U.S business investments have slowed "notably" recently as uncertainties over the economic outlook linger.
"Crosscurrents have reemerged," Powell said. "Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since then, based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook."