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History shows a Fed rate cut isn't always good for stocks

Scott Gamm

Be careful what you wish for.

The stock market has been rallying in recent weeks on hopes of the Federal Reserve will lower interest rates, but history suggests a rate cut can sends stocks on a complicated trajectory.

UBS strategist Francois Trahan notes how excited investors were after the cuts to the Fed funds rates in 2001 and 2007.

But that excitement soon faded. “The S&P 500 (^GSPC) subsequently declined from the first cut to its cycle trough by 33.3% and 47.7% respectively,” Trahan noted.

Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., June 24, 2019. REUTERS/Brendan McDermid

The Fed’s rate cut fuel just wasn’t enough to keep the market afloat.

“These short-lived rallies proved to be a trap for investors as market multiples soon reverted to trend and continued to compress in the face of weaker leading indicators,” Trahan noted.

One of those indicators is earnings growth.

“The ‘Fed Put’ of 2001 and 2007 ended when S&P 500 earnings growth hit 0%,” Trahan noted. “In the last two easing cycles ‘bad news was good news’ for stocks until earnings expectations began to decline.”

As it turns out, earnings expectations have been coming down in recent months. As Yahoo Finance reported on Monday, Wall Street is now expecting a 0.3% decline in year-over-year earnings growth in S&P 500 companies for the third quarter, compared to a previous forecast of a 0.2% gain, according to FactSet. This comes on top of a 2.6% year-over-year decline projected for the second quarter.

“Through our lens, lower rates will only help when they can foster a recovery in leading economic indicators, which history tells us is unlikely to occur before 2020 as rates work with a long lag,” Trahan wrote. “Unfortunately, gone are the days when lower rates led to an immediate recovery in market multiples.”

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Scott Gamm is a reporter at Yahoo Finance. Follow him on Twitter @ScottGamm.

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