Are you hoping rate cuts will boost your stock prices? You may be wrong, here's what investors should do now There are many other variables that decide the trajectory of market returns, like earnings and sentiment. The optics around rate cuts are also a critical aspect governing the way stock prices move. The ‘why, in particular, matters for the markets
After a prolonged wait, the interest rate cutting cycle is finally getting off the mark. The US Federal Reserve’s rate cut of 0.5%—its first rate action after a freeze of 420 days and more than four years since the last cut—turned out bigger than expected. The pivot towards lower interest rates is expected to drive stocks higher. The domestic market has already responded favourably, expecting the RBI to follow suit. However, the party may not necessarily last very long.#sr_widget.onDemand p, #stock_pro.onDemand p{font-size: 14px;line-height: 1.28;} .onDemand .live_stock{left:17px;padding:1px 3px 1px 5px;font-size:12px;font-weight:600;line-height:18px;top:9px} #sr_widget.onDemand .sr_desc{margin:0 auto 0;} #sr_widget.onDemand .sr_desc{color: #024d99;margin-top:10px;} #sr_widget.onDemand .crypto .live_stock .lb-icon{8px 6px 5px 3px !important} #sr_widget.crypto.onDemand a.text{border-bottom:1px solid #ccc;padding-bottom:5px;display:block;width:100%} #sr_widget.onDemand .sr_desc .text p, #stock_pro.onDemand .sr_desc .text p{font-size:12px;font-weight:400;} The US central bank has already indicated that it expects to cut rates further by at least another 1.75% (175 basis points) in this rate cut cycle, through 2026. Conventional wisdom says that stocks tend to do well during falling interest rates. History provides some evidence of this claim. JP Morgan Securities observes that since 1980, five of the 10 best years for the S&P 500 have been when the Fed was cutting rates without a recession (1985, 1989, 1995, 1998, 2019). The timing of the rate cut seems to make an even stronger case for continued buoyancy in the market. The Fed has cut rates 12 times when the S&P 500 was within 1% of its all-time high. The market was higher one year later all 12 times (with a median return of 15%).
However, these statistics mask certain nuances. Rate cuts alone don’t tell the whole story. There are many other variables that decide the trajectory of market returns, like earnings and sentiment. The optics around rate cuts are also a critical aspect governing the way stock prices move. The ‘why’, in particular, matters for the markets. In fact, the optics around the latest rate cut are more unnerving than inspiring. “While the debate on whether the cut will be 25 or 50 bps has been resolved, the move itself has left more questions than answers,” says Anitha Rangan, Economist at Equirus.
Typically, stock prices tend to rise if it is perceived that rate cuts are due to the confidence of a humming economy or when appearing in control of engineering a soft landing for the economy. If, however, the indications are that rate cuts are an attempt to avert a recession, the trajectory can be very different. History brings out this correlation very clearly. Since the mid-1980s, the Fed has eased monetary policy 10 times. Six of these cycles have been associated with recessions; four with a soft landing. When the Fed managed to pull off the latter, stocks moved up. When it failed, stocks typically sank (see visual).
Rate cuts don’t always propel the markets forward Outcomes diverge based on the economic scenario.
There is fear that the US central bank has waited too long to cut rates and has opened the door to recession. “The broad sense has been that 50 bps is a sign of a slowing economy and is the Fed’s wake-up call,” says Ankita Pathak, Chief Macro & Global Strategist, Angel One Wealth. The recent US jobs print is not very encouraging. On this front, the Fed has not appeared very convincing. The higher than expected rate cut flies in the face of its claim that the economy is on a strong footing. This is only the third time in recent history that the Fed has started rate cuts with a 50 bps cut. The previous two times, the economy was in recession.
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The start of the rate cuts in the US is expected to boost inflows into Indian equities in the near term. Trivesh D., COO, Tradejini, remarks, “FIIs, who had pulled out in June and July, are already returning, and with more rate cuts expected, this inflow could continue to grow, making India a top destination for higher returns.”
However, the medium-term trajectory for domestic stocks hinges on how the US economy responds to the new medicine and incremental doses. It will not be immediately clear which scenario—soft landing or recession—eventually comes to pass. This will keep the markets on tenterhooks. “If the US achieves a soft landing and avoids a recession, Indian equities may experience gradual growth. If the global outlook deteriorates, Indian markets, especially mid- and small-cap segments, could face increased volatility,” says Pradeep Gupta, Co-founder & Vice-chairman, Anand Rathi Group. Vipul Bhowar, Senior Director, Listed Investments, Waterfield Advisors, reckons, “The rate cut also raises concerns about the underlying weaknesses in the US economy and could lead to increased market volatility.”
Experts maintain equity investors position for both scenarios. Bhowar insists, “The rate cut presents opportunities for growth in sectors like banking, IT, real estate, and consumer goods in India, but also carries risks due to global economic uncertainties and potential volatility in foreign investment flows.” Apurva Sheth, Head of Market Perspectives and Research, SAMCO Securities, says, “It seems the markets will take time to digest this move. Meanwhile, we would recommend investors to focus on defensive sectors like FMCG & pharma.”
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This story originally appeared on: India Times - Author:Faqs of Insurances
