Maybe the Federal Reserve’s emergency rate cut on Tuesday was the vaccine troubled markets needed in the short-term, even if investors didn’t react in kind at first.
The Jerome Powell-led Fed shocked Wall Street by slashing interest rates by 50 basis points around 10:00 a.m. ET. The Fed said the “fundamentals of the U.S. economy remain strong” but that the coronavirus “poses evolving risks to economic activity.”
Stocks initially popped on news of the cut, but quickly gave up gains as investors rallied around a notion the Fed is perhaps seeing recessionary conditions emerge in the U.S. due to coronavirus. The Dow Jones Industrial Average plunged nearly 800 points by the closing bell. Meanwhile, the Nasdaq Composite and S&P 500 fell 2.8% and 2.9%, respectively.
[Take our quick poll: Do you think the stock market has bottomed?]
But not everyone on the Street is all doom and gloom when it comes to the Fed’s newfound super dovishness.
“Historically, Fed easing is bullish for stocks,” Oppenheimer chief technical analyst Ari Wald said on Yahoo Finance’s The First Trade. “There is a saying out there, don’t fight the Fed. Just given the market has found some support coming into this Fed backstop, and the relative cheapness of stocks now versus the bond market and how low rates are should provide a floor as well.”
If you are a more active trader, the short-term data agrees with Wald’s assessment to respect the emergency powers of the Fed.
After the past seven emergency rate cuts by the Fed, the median price for the S&P 500 has been up 2.8% one week following the move, according to Deutsche Bank strategist Jim Reid. But then the market becomes more treacherous, likely reflecting the economic realities behind an emergency rate cut by the Fed.
Reid’s analysis shows the median price for the S&P 500 six months after one of the most recent seven emergency rate cuts has been a drop of 4.3%. Looking out one year, the S&P 500 has shed 9.2%.
“When you consider the average 1yr price return (excluding dividends) for the S&P 500 is around 6% then that is a considerable 6 months and one year under-performance when the Fed deems it necessary to do an emergency cut,” Reid writes. “1998 was the big positive outlier as you didn’t see a subsequent recession and we moved into maximum bubble phase with the extra stimulus. That would be the bull hope. However for now the market will debate whether they have fired too much of their armory too early.”