History shows the S&P 500 sees a sizable drawdown as Fed starts rate cuts, WFII says
While investors are “clamoring” for the Federal Reserve to start cutting interest rates, history shows losses on the S&P 500 (SP500)(IVV)(SPY) can coincide with the launch of rate-easing cycles, according to Wells Fargo Investment Institute (WFII).
WFII Investment Strategy Analyst Austin Pickle in a note dated Monday charted the S&P 500’s (SP500)(SPY) return and days between the first Fed rate cut in a cycle to the subsequent index low. He found that since 1974, the index’s average drawdown has been about 20% over 250 days following the first Fed rate cut.
“In other words, investors should not equate the first cut as an all-clear stock market signal,” he said. Here’s the chart:
Traders in the fed funds futures market were pricing in September to mark the start of rate cuts, according to the CME FedWatch tool. The Fed’s updated dot-plot released last week indicated policymakers expect to cut the fed funds rate of 5.25%-5.5% by 25 basis points only once in 2024.
Investor focus should be on the rationale for a rate cut, Pickle said. “If the Fed tweaks policy to adjust real rates for falling inflation, we believe stocks will likely perform well over the tactical time frame,” of six to 18 months, he said. “On the other hand, if the Fed is forced to cut aggressively in response to a macro or market disruption, we would expect stock performance to suffer.”
The S&P 500’s (SP500) returns during the past five rate pauses have “maxed out” near 20%, he said. The S&P 500 has gained about 14% in 2024, and headwinds including inflation’s uncertain path are likely to weigh on returns in the near-term, he said. WFII's 2024 year-end target is 5,100-5,300, lower than the S&P 500’s (SPY) level of around 5,458 on Monday.
WFII's 2025 year-end S&P 500 (SP500) target is 5,600-5,800 as it sees inflation contained and solid economic growth after a near-term slowdown supporting earnings growth and a renewed equity rally, Pickle said.