Here’s What the Market Did EVERY TIME the Fed Cut Rates During an Economic Expansion

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We’re just past the midpoint of 2019, and ordinarily that would mean it’s time for the Commodities Halftime Report. That will need to wait until next week, though, as there are more urgent things for me to share with you, starting with a mea culpa.

As you know, the market collapsed in the fourth quarter of 2018, sinking some 20 percent between the end of September and December. Expressed another way, it fell four standard deviations below the mean over 60 trading days—a huge move.

When the market has fallen by that much, it’s historically been a good time to get contrarian because a reversion to the mean hasn’t been too far behind. Mean reversion, as I explain in “Managing Expectations,” is the idea that prices tend to move back to their historic averages eventually.

The reason I’m telling you this now is that I didn’t take my own advice. I believed, as others did, that more pain was ahead. Prices bottomed, but instead of buying, I took money off the table. And watched the market bounce strongly. By the time it became clear that this aging bull market wasn’t slowing down, it was too late. The opportunity had come and gone.

We all have a choice on how we deal with setbacks. When asked once about the single most important lesson he’s learned over the course of his long career, the billionaire hedge fund manager Ray Dalio pointed to his bad bet in the 1980s. He believed the U.S. was headed for a depression, and when one never came, he fell so deeply into debt that he had to borrow $4,000 from his father to make ends meet. The experience “was one of the best things that ever happened to me because it gave me the humility I needed,” he wrote in his bestseller Principles: Life and Work.

I never stop learning, even after four decades spent in global markets. That’s as true now as it was when I first started as a young analyst in Toronto. And I’m pleased to say that, after thoroughly reviewing our models, our investment team and I have great confidence going forward.

Cutting Rates in an Expansionary Environment

The market is now at record highs, and unemployment is way down. Even so, a U.S. rate cut is expected as early as this month. During his congressional testimony this week, Federal Reserve Chairman Jerome Powell raised concerns over slower global growth and trade tensions, which in turn have contributed to weaker demand and manufacturing activity. The most recent Global Manufacturing Purchasing Manager’s Index (PMI) showed that, at 49.4, factories contracted for the second straight month in June. We haven’t seen back-to-back sub-50.0 PMI readings since the second half of 2012.

There’s also a one-in-three chance we could see a full-blown recession sometime next year. That’s according to the New York Fed’s recession probability index, which flashed a 12-year high of 32.9 percent last month. Since 1960, every time the index has surpassed 30 percent, the economy has tanked within the next 12 months.

probability of a US recession has surged to pre-crisis levels
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Despite the risks, the U.S. economy is still expanding—an unusual, though not unheard-of, time for the Fed to consider cutting rates.

So let’s assume for a moment that the Fed does take action next week. What effect would that have on the stock market as well as manufacturing activity?

That’s precisely what analysts at market research firm Fundstrat looked into recently, and what they found is that 100 percent of the time, the market increased in the next three, six, nine and 12 months. The median gain over nine months, in fact, was nearly 18 percent.

Hypothetically, if the same thing were to happen today, that would put the S&P 500 Index at around 3,500 by next April.

Forward market returns following an initial fed rate cut during expansionary periods
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Once again, for those in the back: In every case going back to 1971, when the Fed began a new easing cycle while the economy was expanding, stocks went up three months, six months, nine months and 12 months later. No exceptions.