Excluding recessions, the Fed has cut rates in 14 years without a recession and in 13 of those years—or 93% of the time—the market was positive and returned on average an impressive 15.6%.
After rallying 26% last year, equities reached new highs in January as the economy continues to show impressive strength. While recession risks in the US have receded, geopolitical risk, election risk and restrictive monetary policy all threaten the current rally. That said, investors often focus on the bad, yet there a few reasons investors can be optimistic in today’s market.
One of the pushbacks we receive from clients is the risk of investing at or near all-time highs. However, history suggests that the S&P 500 spends a lot of time making record highs—which is why we invest in stocks in the first place. As highlighted, there is no clear disadvantage, both in the short- and long-term, to invest at record highs vs waiting for the market to sell off. Indeed, since 1970, the average 12-month price return on the S&P 500 after reaching an all-time high is 9.1%, while the average return when investing in all other days is 8.7%.
In addition, the macro backdrop is a supportive one assuming the Fed begins reducing interest rates this year. In the 44 years since 1980, there have been 23 years where the Fed cut rates at least once. In 18 of those 23 years, the stock market was positive 78% of the time with an average calendar year return of 10.3%. It’s generally understood that the Fed normally cuts rates in response to a recession and indeed in 9 of those 23 years (40% of the time) the economy was in a recession. Excluding recessions, the Fed has cut rates in 14 years without a recession and in 13 of those years—or 93% of the time—the market was positive and returned on average an impressive 15.6%. Suffice it to say, if our base case plays out for zero recessions and for three rate cuts from the Fed, this has historically been a great backdrop for strong stock market performance.
Moreover, a backdrop of positive earnings growth after roughly flat growth last year is supportive for equity prices. That said, although profits should experience healthy growth this year, there are downside risks as forward guidance has been a cautious and the economy slows back to trend. Investors should therefore measure twice and cut once; we continue to prefer quality in large and mid-caps over small caps, and balanced exposure to the Magnificent 7 and the broader market.