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Interest rate cuts have a complicated history with the stock market: Morning Brief
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One of the most notable bears on Wall Street finally turned this week.
Morgan Stanley’s Mike Wilson raised his price target for the S&P 500 over the next 12 months from 4,500 to 5,400, a 20% jump amid a market that Wilson sees defined by “greater than normal uncertainty.” Josh Schafer has more on Wilson’s call here.
And in his report, Wilson included a chart that serves as a note of caution for stock market bulls looking for lower rates to drive the next leg of this recovery.
“[There] there is a wide range of return outcomes throughout history after the cutting cycle begins,” Wilson wrote.
“In many ways, this analysis sums up our outlook well – a balanced risk/reward profile in the average/baseline view, but the potential for a wide range of scenarios to play out. Again, prepare for some changes notable in sentiment, positioning and pricing.”
The average annual return of the S&P 500 is about 10%, making the 12-month returns that follow rate cuts, on average, well below this specter. And with the exceptions of 1974, 1989 and 2019, the S&P 500’s returns for the following year after rate cuts have typically been well outside this historical average, both high and low.
All else equal, lower interest rates benefit riskier assets like stocks, reducing the hurdle to return that makes stocks preferable to something like fixed income.
What Wilson’s data reminds us, however, is that rate cuts are not something the Federal Reserve typically does “just because.”
Even the winning years in Wilson’s chart are reminders of precarious moments in financial market history – the 1994 bond market crash gave rise to James Carville’s famous complaints about “bond vigilantes”, and the emerging market crisis in 1998 and the collapse of LTCM forced the Fed will take drastic action to save a single hedge fund.
Go back 18 months and Wall Street expected a recession to trigger rate cuts. Today, the Fed is looking for “greater confidence that inflation is falling sustainably to 2%” as a catalyst for lower rates.
Federal Reserve Chairman Jerome Powell holds a news conference following a two-day Federal Open Market Committee meeting on interest rate policy in Washington, May 1, 2024. (REUTERS/Kevin Lamarque/File Photo) (REUTERS/Reuters)
Last year’s view on rate cuts was in line with history: a negative shock prompts the Fed to act. The current view is anomalous.
Although, as Wilson notes, in today’s market, what else would you expect?
“The past few months have been a microcosm in this regard, as economic growth data cooled once again after a period of strength, while inflation data was choppy,” Wilson wrote.
The story continues
“In short, macroeconomic outcomes have become increasingly difficult to predict as data has become more volatile. We see this environment persisting.”
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