The Investment Scientist

What do Fed rate cuts mean to your stock portfolio?

Posted on: February 27, 2008

Last month, the Fed took a drastic step to cut rate twice by a total of 125 basis points. And with a drop of 225 basis points since last fall, what does this say about likely stock returns? Let’s look at the historical data.

Since 1950, the Fed cut more than 200 basis points 11 times in attempts to simulate a faltering economy. Economists believe it takes six months for the rate cuts to take effect which should last for as long as three years. Therefore I examined the one- and three-year returns of the S&P 500 Index and the Fama/French Small Cap Value benchmark portfolio for each rate-cut period.

After cuts of 200+ basis points, the average one-year return for the S&P 500 was 13.5% with two negative-return periods. The average three-year returns for the S&P 500 was 31.8% with one negative-return period.

However, the Fama/French Small Cap Value benchmark portfolio fared better. The one-year average return is 34.5% with no negative returns. The three-year average return was 100.5% with just one negative-return period.

    Periods of 200+ bp rate cuts S&P 500
    1 year return
    Small Value
    1 year return
    S&P 500
    3 year return
    Small Value
    3 year return
    Oct 1957 – Mar 1958 32% 64% 55% 106%
    Apr 1960 – Jan 1961 11% 23% 25% 47%
    Apr 1970 – Nov 1970 8% 12% 10% -1%
    Jul 1974 – Oct 1974 21% 34% 25% 149%
    Apr 1980 – May 1980 -19% 46% 46% 175%
    Jan 1981 – Feb 1981 -14% 10% 20% 131%
    Jun 1981 – Sep 1981 4% 25% 143% 141%
    Apr 1982 – Jul 1982 52% 96% 78% 174%
    Aug 1984 – Nov 1984 24% 31% 41% 39%
    Sep 1990 – Mar 1991 8% 29% 19% 89%
    Sep 2000 – May 2001 -15% 19% -11% 57%
    Average 13.5% 35.4% 31.8% 100.5%

Data sources: Federal Reserve, Kenneth French data library

It’s apparent from historical data that Fed rate cuts don’t guarantee making money in stocks. However, they do increase the odds of doing so— particularly with small cap value stocks. (Note: the odds of losing money with the S&P 500 index in any given year is about 30%.)

Martin Zweig once said:

Don’t fight the Fed!

That could be a very wise counsel!

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2 Responses to "What do Fed rate cuts mean to your stock portfolio?"

[…] Zhuang at The Investment Scientist has a nice table summarizing stock returns after periods of Fed rate-cutting.  His familiar conclusion is the quote […]

[…] InvestmentScientist gives a rundown on what it means when feds cut the rates. How does that affect your […]

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC. He is also a regular contributor to Morningstar Advisor and Physicians Practice. To explore a long-term wealth advisory relationship, schedule a discovery meeting (phone call) with him.

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