CAMS Weekly View from the Corner - Week ending 7/26/24
July 29, 2024
In our previous edition we shared how signals abound throughout markets that the Federal Reserve will be cutting rates as the fall season approaches.
There is a view purported onto the masses via mass media on down through business media that once the Fed begins to cut interest rates it is clear skies for the stock market. The ole if the Fed would just cut rates it will all be good view is implied and sometimes explicitly stated.
Collective stock market participants themselves amp up on this view many times by bidding up the market on a mere hint of Fed rate cuts near-term. This holds true current day as much as it does through decades of history.
What makes this quite interesting if not outright strange is how these same collective participants seem to be oblivious to their own history of behavior when interest rate reductions begin to enter the socioeconomic landscape.
Perhaps this underlines how hope springs eternal in the human psyche be it individually and/or collectively. Awesome right. Would you want to live life without a sense of hope as a general backdrop of existence – be it individually or collectively? Its inverse – hopeless – leans right into misery.
Even though collective stock market participant’s behavioral history offers they struggle with rate cuts, as rate cuts are unfolding, the anticipation of rate cuts offers hope that this time will be different.
The problem is many times the general storyline remains the same and as the rate cuts unfold the hope of it being different “this time” fades into the ether.
The Extreme Short Version of a Fed Cutting Cycle
The extreme short of the general storyline offers the Fed cuts rates in light of a weakening economic backdrop. The economy weakens further and rate cuts continue to unfold. As time moves along the weakening economic landscape begins to show up in stock market listed company results.
As sales become challenged for these companies ultimately bottom line profits begin to be impacted.
Companies begin reporting lower profit results along with lowering their forward expectations of such. As this unfolds collective participants realize they want little to do with bidding up share prices of companies who are experiencing reduced profit results and equally bad – expectations of reduced profits to continue.
Profits are the lifeblood of a company’s value. This along with confidence that profits will continue (no one-trick ponies) as well as grow in an upward trajectory.
If this is not the case - be it for an individual company or more collectively for the stock market as a whole - their value will be reassessed.
With this reassessment collective participants will lower the stock price(s) to more accurately reflect the reality of this new economic backdrop and how X company(s) is faring within it.
This entire process plays out over time and during the process we consistently see an ebb and flow in the trend of X company or the stock market as a whole. This elicits an in-house phrase used consistently that no market moves up or down in a straight line. Rather, regardless of trend direction, there is a series of ebbing and flowing of share prices.
The ebbing and flowing is the proverbial noise if you will while it is the overriding trend that matters most.
21st Century History
In this century we have experienced three time frames whereby a rate cutting cycle unfolded. To be fair to the phrase “cycle” we focus on two periods.
The third was the Covid time frame which was not a methodical cycle of reducing rates as much as it was an immediate cliff-dive of rates along with a massive free money expansion fanned throughout society.
Interestingly though, market behavior relative to rate cuts in that time period offered a similar theme as the below storylines depict, albeit in a compressed time.
Below we isolate the first two periods and use them as examples how Fed rate cutting campaigns and stock market behavior do not always play out as perhaps many would assume.
Above is the S&P 500 stock index depicted for the three year time frame of 2000-2002. The blue line represents the Federal Reserve’s Effective Fed Funds rate which is their benchmark interest rate.
The chart clearly shows the consistent reduction in interest rates by the Fed while our black down arrow highlights the overriding theme for the stock market in the three year period.
Speaking to our general storyline of Fed rate cutting cycles note the ebb and flow of stock market pricing behavior all while an overriding clear downtrend was in place. As offered, in markets nothing goes up or down in a straight line.
Collective market participants would reassess, begin to bid up shares only to reassess again and push share prices lower. Through the process an overriding downtrend remained in place.
Above is our second period which encompasses 2007 through the front part of 2009. A similar storyline unfolds directly above. The Fed began a rate cutting cycle depicted by the blue line while the overriding result was a notable downtrend highlighted with our black downtrend arrow.
Similar to our first chart also note the ebb and flow that unfolded within the well established overall downtrend.
The Overriding Point
The point of this edition is not to get into the myriad of discussion points that are elicited when entering into the topic of Fed rate cuts.
We have only one central theme here and that is to share how market participant history offers the reality of a rate cutting cycle can be treated far less enthusiastically by participants than one would casually think.
Interestingly, if not strangely as offered above, it is as though they are unaware of their own history of trading once rate cuts begin.
We attribute that to built-in human hope that this time it will all go smoothly. Importantly, this time perhaps it will – and maybe it will not.
With the above we are emphasizing in-house that this is the time to increase focus not to let up on such which can easily be done under the view that rate cuts are coming.
A casual expectation that rate cuts by the Fed will equal an all clear downstream stock market experience does not always pan out via stock market history. For our part in managing assets under our care we are focused on this historical reality and consequently are not taking anything for granted.
An upward trend attempt is not treated as trend certainty because the Fed will be cutting rates as an example. As displayed in the above charts, trend attempts can be quite prevalent in rate cutting cycles only to be turned back again and again.
2024 has a lot left in the tank which surely promises to be quite interesting if not challenging. Stay focused – be sharp.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
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