A look at how stocks perform before and after the Fed's first rate cut — and how it may be different this time

Published Wed, Jan 31 20241:38 PM ESTUpdated Wed, Jan 31 20243:28 PM EST

How markets perform after the first Fed rate cut may be more complicated this time than investors expect. History shows that stocks typically rally after the Federal Reserve starts to lower rates, but the way it bears out has hinged largely on where the economy is as well. Typically, the Fed has not eased up on the brakes until it was near the end of a downturn, but the central bank is currently deliberating when to lower rates with a U.S. economy that is only showing modest signs of cooling. On average, the Dow Jones Industrial Average has climbed 14.4% one year after the first rate cut, with similar trends in the S & P 500, according to data from Ned Davis Research. But if a recession occurs in the year after, the Dow posted just a 9.8% gain. Without a recession, that spikes to 23.8%. "The phase of the economic cycle has mattered," Ed Clissold, chief U.S. strategist at Ned Davis Research, wrote in a report last week. "The worst performances have come when the economy was not in a recession at the time of the first cut but was poised to fall into one in the next year, on average." Take 1989, for example. Sam Stovall, chief investment strategist at CFRA Research, said the S & P 500 fell into a short bear market and mild recession the year after the Fed first cut rates in June 1989. The following summer saw Iraq invade Kuwait, driving up oil prices at the start of the campaign that led to Desert Storm. The S & P 500 fell almost 7% in 1990. By contrast, in 2001, the Fed started cutting rates after the S & P 500 had peaked from the dot-com bubble in early 2000, meaning lower interest rates helped soften the blow of a weaker economy. But equities still fell 13% that year. In 2007, the Fed first started lowering rates after the stock market peaked that year, with Bear Stearns and Lehman Brothers both failing in 2008. The S & P 500 rose just 3.5% in 2007 before collapsing 38% in 2008. A year after the Fed cut rates in 2019, the Covid-19 pandemic weighed on markets. "The odds don't favor this economy getting away unscathed," Stovall said. "And so, I think that investors have to be aware of the potential of a mild recession to kick in sometime in 2024 or early '25." Slowdown and consolidation Stovall said a recession is not in his base case scenario, though he anticipates a slowing of the economy as well as some consolidation of gains in stocks after their recent rally. How stocks perform will be especially important as Wall Street assesses when the central bank will cut rates. The Fed on Wednesday held benchmark interest rates steady, but in a statement indicated it may not be quite ready to start cutting rates yet either. During the post-meeting press conference, Fed Chair Powell said a March rate cut is not likely . "The old worry is that the Fed always starts raising rates too late … and too long, which then throws the economy into a recession, and the stock market into a correction or even a bear market," Stovall said. "That's the traditional worry," Stovall added. "And I think history would bear that out."