Last month, the Fed took a drastic step to double the rate by a total of 125 basis points. And with a drop of 225 basis points from last fall, what does that say about the potential stock return? Let’s look at the historical facts.
Since 1950, the Fed has lost more than 200 basis points 11 times in an effort to mimic a weak economy. Economists believe the rate cut will take six months to take effect, which should last up to three years. So I examined the S&P 500 index for each rate-cut period and the one- and three-year returns of the FAMA / French Small Cap Value benchmark portfolio.
After deducting 200+ basis points, the average one-year return of the S&P 500 was 13.5% and two negative-return periods. The average three-year return of the S&P 500 was 31.8% with a negative-return period.
However, the Fama / French Small Cap Value benchmark portfolio does well. One year average return is 34.5% without any negative return. The three-year average return was 100.5% with only one negative-return 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
It is clear from historical data that lowering the Fed rate does not guarantee monetization from stocks. However, they do increase the likelihood of that happening – especially with small cap stocks. (Note: The probability 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 advice!