Will Rate Cuts Boost the Stock Market? A Global Equity Investment Guide

Moomoo News Global joined discussion · Sep 19, 2024 20:24

The Federal Reserve on Wednesday implemented its first rate cut in over four years, reducing the benchmark rate by 50 basis points to a range of 4.75%-5%.

The move surpassed Wall Street's expectations. Analysts had generally anticipated a 25 basis point cut, while the futures market had priced in a 61% probability of a 50 basis point cut and a 39% probability of a 25 basis point reduction.

Source: Trading Economics

Market Response to First Rate Cut

Stocks initially surged after the Fed's announcement but reversed course by the close on Wednesday. The Nasdaq slid 0.31%, the S&P 500 fell 0.29%, and the Dow Jones Industrial Average dipped 0.25%.

Michael de Pass, global head of rates trading at Citadel Securities, observed that the market's reaction was relatively calm compared to the volatility experienced in recent months.

Gargi Chaudhuri, head of investment and portfolio strategies for the Americas at BlackRock, attributed Wednesday's slight stock decline to profit-taking ahead of seasonal weakness rather than concerns about the economic outlook.

"I would not be surprised to see some pullback [in equities] over the next couple of weeks but only because we had such a strong performance up until this point,” she said.

The $S&P 500 Index (.SPX.US)$ has risen nearly 18% this year, pulling back on Tuesday and Wednesday after hitting record highs.

Notably, small and mid-cap stocks continued to rise on Wednesday. The $Russell 2000 Index (.RUT.US)$ edged up 0.04%, while the S&P MidCap 400 Index gained 0.05%.

James St. Aubin, chief investment officer at Ocean Park Asset Management, told MarketWatch that the modest gains in small and mid-cap stocks reflect a clear vote of confidence in the U.S. economy and the Fed's management capabilities.

Futures for the three major indices surged pre-market. Nasdaq 100 futures $E-mini NASDAQ 100 Futures(MAR5) (NQmain.US)$ advanced over 2%, S&P 500 futures $E-mini S&P 500 Futures(MAR5) (ESmain.US)$ and Dow Jones futures $E-mini Dow Futures(MAR5) (YMmain.US)$ climbed over 1.5%.

Prospects of Further Rate Cuts

The Federal Reserve labeled its substantial rate cut as a measure to bolster economic resilience, rather than a reaction to recent labor market weakness. "The labor market is actually strong," Fed Chair Jerome Powell stated at a press conference. "Our policy action today is intended to maintain that strength."

Nick Timiraos, often referred to as the “Fed whisperer,” reported that the Fed's significant rate cut aimed to compensate for lost time. "While some Fed officials argued recently that the economy didn't warrant a half-point cut, others concluded that this summer's labor-market cooling justified a larger reduction, as the Fed was effectively catching up for lost time," he wrote.

According to the Fed's updated dot plot, 10 out of 19 officials support another 50 basis points cut this year. However, Chair Jerome Powell stated that the Fed can adjust its pace of rate cuts, suggesting investors should not assume the current rate of cuts will continue.

Will Rate Cuts Boost the Stock Market? A Global Equity Investment Guide

Market expectations appear more aggressive, with the CME FedWatch tool indicating a 63% probability of a 25 basis-point rate cut in November. The likelihood of a cumulative 75 basis-point cut or more by year-end stands at 69%.

Bloomberg economists, including Anna Wong, believe, "The updated dot plot suggests a gradual path of rate cuts ahead, indicating the Fed views the 50-basis-point move as a preemptive measure sufficient to stabilize the labor market."

Paresh Upadhyaya, Director of Fixed Income and Currency Strategy at Amundi US, said, "The market pressured the Fed to cut 50 basis points. While markets might be keen to price in another 50-basis-point rate cut, the changes to the statement imply the Fed remains data-dependent and could easily downshift to a 25-basis-point cut."

Investment Strategy

1. US Stock

The stock market's performance post-rate cut hinges on whether the economy hits a recession. Evercore ISI research shows that since 1970, the S&P 500 averages a 14% gain in the six months after a Fed rate cut during non-recessionary periods. Conversely, during recessions, the index averages a 4% decline in the same timeframe.

Of the last eight initial rate cuts, only three were by 50 basis points. The most recent ones in 2001 and 2007 led to recessions, with the stock market suffering significant declines over the following 3, 6, and 12 months. However, after the 50 basis point cut in 1987, the economy avoided a recession, and the market saw substantial gains within 12 months.

Most analysts see the significant rate cut as a clear sign of the Fed's commitment to achieving a soft landing for the economy, which is expected to ultimately lift the stock market.

“The Fed’s jumbo rate cut shows a clear intention of the Fed to support the US economy and aim for a ‘soft landing,’” wrote Nomura strategists led by Chetan Seth in a report. “As long as the US manages to avoid a recession in the coming months, the Fed’s pre-emptive rate cuts should generally support stocks.”

Jeff Schulze, head of economic and market strategy at ClearBridge Investments, stated, “I think this dramatically increases the odds of the Fed being able to stick the landing, which ultimately will be bullish for risk assets.”

The rate cut cycle has notably benefited the healthcare, financials, communications, real estate, consumer staples, and utilities sectors.

1) Health Care: Historical trends show that biotech stocks often surge during Federal Reserve rate cuts. As noted in a previous article, "Ready for Fed Rate Cuts? Biotech's Potential to Watch," leading biopharma companies have hit new highs this year, posting gains between 18% and 64%. Top performers in this sector include $Eli Lilly and Co (LLY.US)$, $Novo-Nordisk A/S (NVO.US)$, $Intuitive Surgical (ISRG.US)$ (ISRG), $HCA Healthcare (HCA.US)$, $Boston Scientific (BSX.US)$, $Regeneron Pharmaceuticals (REGN.US)$, $AstraZeneca (AZN.US)$, $AbbVie (ABBV.US)$, $Novartis AG (NVS.US)$, and $Stryker Corp (SYK.US)$.

2) Financials: As discussed in "Seizing the Opportunity in Surging Financial Stocks," the financial sector harbors significant investment opportunities during rate cuts. Lower rates reduce borrowing costs for banks, improve net interest margins, and can stimulate loan demand. Notable gainers this year include $Progressive (PGR.US)$, $KKR & Co (KKR.US)$, $Allstate (ALL.US)$, $Aflac Inc (AFL.US)$, $American Express (AXP.US)$, $Berkshire Hathaway-B (BRK.B.US)$, $Arthur J. Gallagher (AJG.US)$, $JPMorgan (JPM.US)$, $First Interstate BancSystem (FIBK.US)$, and $Goldman Sachs (GS.US)$.

3) Communication Services: In "Communication Services Sector to Watch as Rate Cuts Draw Near," we noted that rate cuts reduce financing costs for communication services companies, enabling increased investment in R&D, infrastructure, and market expansion. Major gainers this year include $Spotify Technology (SPOT.US)$, $Meta Platforms (META.US)$, $TKO Group Holdings (TKO.US)$, $Fox Corp-A (FOXA.US)$, $Netflix (NFLX.US)$, $T-Mobile US (TMUS.US)$, $Verizon (VZ.US)$, $Liberty Formula One-A (FWONA.US)$.

4) Consumer Staples: As highlighted in "Seizing Opportunities in Rallying Consumer Staples Stocks," rate cuts typically boost consumer confidence and purchasing power, benefiting the defensive consumer staples sector. $Walmart (WMT.US)$, $Costco (COST.US)$, $Altria (MO.US)$, $Philip Morris International (PM.US)$, $Unilever (UL.US)$, $Colgate-Palmolive (CL.US)$, $Coca-Cola (KO.US)$, $Kimberly-Clark (KMB.US)$, and $Procter & Gamble (PG.US)$ have all hit record highs this year, with gains between 17% and 46%.

5) Utilities: Our analysis in "Are Utilities Becoming the New Equity Sector When Fed Cuts Rates? " reveals that utility stocks offer attractive dividend yields, providing an alternative investment option in a low-rate environment. Top performers this year include $Vistra Energy (VST.US)$, $Constellation Energy (CEG.US)$, and $NRG Energy (NRG.US)$, which have seen gains of 121%, 67%, and 65%, respectively.

2.Asian Markets

A potential rate cut by the Federal Reserve could bolster Asian markets, analysts say. Central banks across various Asian economies may follow suit, improving the outlook for their assets.

"A Fed rate cut could enhance risk appetite in Asian equities, driving capital into emerging markets as investors seek higher returns," said Manish Bhargava, CEO of Straits Investment Management.

Global capital has been flowing steadily into Southeast Asian markets, seeking new growth opportunities. Foreign funds have poured into ASEAN stocks for five consecutive weeks, with the MSCI ASEAN Index trading near its highest level since April 2022, Bloomberg reported last week.

Nomura Securities highlighted in its latest Asia market strategy report that with the Fed entering a rate-cutting cycle, now is an opportune time to increase holdings in Southeast Asian equities. The firm upgraded its ratings on Indonesian and Malaysian stocks, citing robust macroeconomic fundamentals. Goldman Sachs also upgraded Thailand to market weight from underweight this month.

Moreover, Some institutions have begun to build positions in Chinese assets. Chinese assets are currently undervalued as global institutions reduce their holdings amid geopolitical tensions and weak economic performance. Bloomberg data indicates the MSCI China forward price-to-earnings ratio stands at just 42% of the S&P 500’s.

In early September, UK asset management giant M&G announced the launch of a China equity fund. "We actually started buying selectively some consumer staples and consumer discretionary names," said Fabiana Fedeli, CIO of multi-asset at M&G Investments, on Wednesday. "They generate very high free cash flow. They're giving it back to shareholders in terms of buybacks and dividends."

Source: WSJ, MarketWatch, Trading Economics, Financial Times, bloomberg, Investing

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