As investors brace for a potential US interest-rate cut in September, a new study by the Franklin Templeton Institute examines economic cycles over the past 50 years (since 1972) and provides historical insights to guide investment decisions.
Chris Galipeau, Senior Market Strategist at Franklin Templeton Institute, says: “Our study indicates that when the Fed cuts rates during an economic expansion, both equity and Treasury markets have historically performed well.
“With the financial markets anticipating the Fed’s first interest-rate cut of the next easing cycle in September, followed by a likely second cut in December, many wonder how stocks will react. Will investors interpret the cut as a bullish sign to prolong the economic expansion, or will it trigger bearish sentiments, signalling a potential slowdown? To address these concerns, we turned to history.
“First, it’s crucial to distinguish between rate-cutting cycles tied to recessions versus expansions. Historical data since 1972 shows that rate cuts during expansions often coincide with subsequent bull markets, whereas cuts during recessions are frequently followed by market setbacks. The current US economy appears to be in expansion, and barring any external shocks, a rate cut in September would likely be classified as expansionary.
“Second, rate-cutting cycles since 1990 reveal that nearly all equity market sectors have delivered positive returns one year after an expansionary rate cut, with large caps, growth stocks, and Nasdaq leading the charge.
“Third, history suggests that it might be wise to add to equity positions if the market initially declines following the first rate cut. Historically, equities have typically rallied six and 12 months after the first cut, regardless of whether the economy remained in expansion or entered a recession.
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“Fourth, in the four instances of expansionary rate cuts, the S&P 500 Index experienced short-term drawdowns, with three of these being brief and shallow—under 5%. Only in one instance did the S&P 500 Index decline by 10%, a level commonly considered a correction.
“Finally, in terms of asset allocation, Treasuries have also historically performed well following the initial rate cut of a cycle, given their inverse relationship to interest rates. Treasuries generated positive returns across multiple periods after the start of rate-cutting cycles dating back to 1972. Additionally, Treasuries often outperformed equities during the lowest points of post-rate-cut market drawdowns, suggesting that they could significantly enhance the risk-reward profile of a multi-asset portfolio.
“Given the current conditions we anticipate the continuation of the bull market, though with increased volatility. Notably, adding to equity positions after the rate cut may be an attractive strategy.
“Our analysis of historical cycles shows that, more often than not, the equity market has trended higher in the six months following the first rate cut, regardless of whether the economy was in expansion or recession. Historically, US large- and small-cap stocks have risen on average over six and 12 months after the first rate cuts.
“Typically, bond prices and returns are highly sensitive to Fed easing (and tightening) cycles, given that bond prices move inversely to rates. It is therefore unsurprising that, in all easing cycles (expansion or recession) since 1972, US Treasuries have performed positively, as measured by the Bloomberg US Treasury Total Return Index (Unhedged).
“The relative performance of Treasuries and equities showed significant differences based on economic conditions. In recessionary rate-cut cycles, US Treasuries tended to outperform the S&P 500 Index, especially in the shorter periods of three, six, and nine months after the first cut. In expansionary rate-cut cycles, Treasuries performed positively but tended to lag behind the gains of the S&P 500 Index in each period.”
