Michelle ThompsonWith the Federal Reserve lowering interest rates by half a percentage point, it’s a good time for investors, households, and businesses to reassess their financial positions.
On Wednesday, the Fed reduced interest rates, the first decrease since March 2020. This follows a period where the central bank raised rates to their highest level in 23 years to counter inflation driven by near-zero borrowing during the Covid pandemic.
In theory, lower interest rates should be beneficial for the stock market. Reduced borrowing costs allow companies to reinvest and return profits to shareholders. However, it also reflects the current state of the economy and its future direction. The Dow rose 1.6% over the week, the S&P 500 increased by 1.4%, and the Nasdaq Composite saw a 1.5% gain, with both the Dow and S&P 500 reaching record highs.
Historically, the S&P 500 has averaged a 5.5% increase in the 12 months following a rate cut, based on LPL Financial data covering nine rate hike cycles since the 1970s. Still, some investors anticipate increased volatility in the coming months due to uncertainties. While the labor market remains strong by historical standards, it has weakened recently. Inflation, though significantly reduced since the Fed started raising rates in 2022, is still above the central bank’s 2% goal. Whether the U.S. economy can avoid a recession remains uncertain.
Jeff Buchbinder, chief equity strategist at LPL Financial, noted in a report that although a “soft landing” is possible, concerns about the Fed’s policies and uncertainties surrounding the upcoming presidential election could lead to a volatile fall in stock markets.
The Fed is unlikely to reduce rates as quickly as they were raised unless economic conditions worsen. Powell cautioned that future rate cuts won’t follow the same half-point pace. The Fed forecasts additional cuts of half a point in 2024, with a full percentage point drop over the next year.
Interest rate cuts take time to impact the economy. Though mortgage rates and bond yields are starting to decline, businesses and consumers may not immediately feel the effects.
Defensive sectors like health care, utilities, and consumer staples typically perform well in the initial six months of a rate-cutting cycle, according to Buchbinder. While Powell emphasized that the rate cut aims to “support the labor market,” rate cuts often signal an economy in decline, making traditionally safer stocks more appealing to investors.
Eric Diton, managing director at Wealth Alliance, advises investors to focus on growth stocks with strong earnings potential. Tech stocks have seen gains following the Fed’s rate cut, with Tesla up 3.5%, Meta Platforms up 7%, and Apple up 2.6%.
Diton also suggests that investors with significant investments in Big Tech should consider other sectors that could benefit from lower rates.
Small-cap stocks, for instance, often gain from lower rates due to their large amounts of floating-rate debt. The S&P SmallCap 600 index increased by 2.2% this week.
“Diversify your holdings,” Diton recommends.
