How US stocks react in Fed easing cycles



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By Lewis Krauskopf

NEW YORK (Reuters) – All US rate cuts are not created equal, at least as far as the reaction of the stock market is concerned.

The Federal Reserve should lower its interest rates when it will issue its policy statement Wednesday at the end of a two-day meeting. This would be the central bank's second cut this year, after a 25 basis point cut at the July monetary policy meeting, the first rate cut since 2008.

Just last week, the markets were expecting a probability of more than 90% that the Fed would lose a quarter of a point more than its overnight lending rate, which is currently in the range of 2.00 % to 2.25%.

Based on the past performance of the stock market as a result of a rate reduction, the market return could be related to the severity of the current economic situation and to the success with which the Fed would appear to have managed to avoid a slowdown.

Of the eight cycles of easing recorded since 1981, four were identified as "insurance" cycles, when problems were looming, but the economy was not in recession, while four occurred as the economy entered or was already in recession, according to a study by Allianz Global Investors.

<p class = "canvas-atom-canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "After a year, the benchmark S & P 500 <.SPX> an average of 20.4% during insurance cycles, while the index fell an average of 10.2% during pre-recession cycles, according to Allianz. "data-reactid =" 28 "> After a year, the benchmark S & P 500 <.SPX> According to Allianz, the index dropped 10.2% on average during insurance cycles, while the index dropped 10.2% on average during insurance cycles.

(Graph: Unworn cycles not created equal: https://fingfx.thomsonreuters.com/gfx/editorcharts/USA-ECONOMY-FED/0H001QX678CV/eikon.png)

Another distinction in softening cycles: according to Jefferies research, small cap stocks tend to outperform large caps. Small cap stocks grew overall by 28% in the 12 months following the first rate cut, compared to 15% for large caps, the company said.

According to Steven DeSanctis, Jefferies' equity strategist, smaller companies are perceived to be more influenced by the state of the US economy and heavier debts or weaker balance sheets, and lower rates should improve both. situations.

(Chart: Small cap stocks have largely beaten after rate cuts: https://fingfx.thomsonreuters.com/gfx/editorcharts/USA-ECONOMY-FED/0H001QX698D1/eikon.png)

<p class = "canvas-atom-canvas-text Mb (1.0em) Mb (0) – sm Mt (0.8em) – sm" type = "text" content = "Following a second rate cut in a cycle, which Wednesday's would be, the Dow Jones Industrial Average <.DJI> The second half of the year, after a second rate cut in a cycle, which would be Wednesday, the Dow Jones Industrial Average <.DJI> earned an average of 20.3% a year later, according to Ned Davis Research.

"Perhaps because the second reduction reflects the Fed's commitment, or perhaps because the first reduction cash started working in the system, the gains were immediate, with an average jump 9.7% three months after the second cut, "Ed. Clissold, chief US strategist at Ned Davis Research, said in a recent report.

(Chart: Stock performance after the second Fed reduction: https://fingfx.thomsonreuters.com/gfx/editorcharts/USA-ECONOMY-FED/0H001QX6C8D7/eikon.png)

The fact that the Fed seems ready for a 25 basis point reduction, as opposed to a larger cut of 50 basis points, could bring better news for equities.

Over the last 40 years, while the first two reductions in a soft cycle were only 25 basis points, the S & P 500 has always been higher six and twelve months later, according to Ryan Detrick, senior market analyst at LPL Financial. Yields are more mixed when one of the cuts was 50 basis points.

"History suggests that bulls should aim for a 25 basis point reduction this week, as they are more considered" insurance cuts "compared to a 50 basis point cut, which could mean that the Fed will see real problems later, "said Detrick.

(Chart: Fed rate cuts and stocks: When bigger means worse: https://fingfx.thomsonreuters.com/gfx/editorcharts/USA-ECONOMY-FED/0H001QX798FW/eikon.png)

(Report by Lewis Krauskopf, edited by Alden Bentley and Leslie Adler)

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