The S&P 500 gapped up to a record high on Thursday, a day after the Federal Reserve kicked off its easing cycle with a bang. Markets seem to be taking Fed Chairman Jerome Powell's soft-landing commitment to the bank, and the Fed's track record is pretty impressive — especially when rate cuts succeed in averting recession.
Granted, the initial reaction to the Fed's 50-basis-point rate cut on Wednesday suggested a bit of an anticlimax. Following a seven-session winning streak, the S&P 500 nudged past its prior intraday record, only to end the session modestly in the red. But the post-Fed rate-cut rally looks to be getting in gear this morning.
S&P 500 Returns After First Fed Rate Cut
Over the prior 11 rate-cutting cycles back to 1982, the S&P 500 has gained 9.1% on average in the six months following the first cut. The major exceptions came after the Fed began cutting in 2001 and 2007, because Fed easing didn't prove sufficient to avert recession and prevent a hit to S&P 500 earnings.
Excluding 2001 and 2007, the S&P 500 has marched to a 13.5% average gain following the first Fed rate cut.
The story is much the same over the year following a rate cut. The S&P 500 has averaged a 14.3% 12-month gain. But that rises to 21% when you take 2001 and 2007 out of the equation.
How This Fed Rate-Cut Cycle Is Different
The ho-hum initial reaction to Wednesday's big Fed rate cut isn't too surprising when you consider where the S&P 500 has come from — and not just its 4% rally over the prior week. The S&P 500 just racked up its biggest 12-month gain ahead of any rate-cutting cycle back to 1982, with a 26.6% advance.
The average gain leading up to the prior 11 rate-cutting cycles was 9%.
Here's another way this cycle stands out. The Fed has never started a rate-cutting cycle when the S&P 500 valuation was so high, based on 12-month forward earnings estimates. FactSet puts the S&P 500 valuation at 21.2 times forward earnings estimates.
The only prior Fed rate-cut cycle that comes close was in 1998, when the S&P 500 valuation started near 20 times forward earnings and proceeded to rise to 25 — before the dot-com bubble burst. By comparison, the 1995 rate-cutting cycle started when the S&P 500 was valued at less than 15 times forward earnings.
Analyst Vs. Fed Projections
Notably, today's high valuations are factoring in analysts' outlook for strong earnings growth. FactSet S&P 500 estimates show earnings per share rising 15% in 2021, to $276.83 from $240.51.
A key question is whether that 15% EPS growth will be attainable if the U.S. economy grows 2% next year, as Fed projections show. Either analysts may be too optimistic, or the Fed may not cut rates as many times as now expected.
Fed projections signaled another half percentage point in rate cuts this year and a full percentage point in cuts next year.
Big Fed Rate Cut Gets Mixed Reviews
"We still expect the stock market to climb to new record highs after the November presidential election," investment strategist Ed Yardeni of Yardeni Research wrote after the Fed rate cut. "Now that the Fed is stimulating the economy, the hard-landing crowd should disperse."
With funding less expensive to come by, Yardeni expects Russell 2000 small-cap companies, value stocks and the S&P 493 — minus the Magnificent Seven — to play catch-up.
"The Fed wants to initiate a rate cut cycle without starting to inflate an asset bubble, but 50 bps might have been too aggressive," wrote Scott Helfstein, Head of Investment Strategy at Global X. "A larger cut probably was not needed out of the gate, but that should support risk-on asset allocation."
S&P 500
The S&P 500 powered ahead 1.7%, clearing 5,700 for the first time in Thursday stock market action. The S&P 500 had been consolidating since its prior closing high on July 16.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
