Don’t Believe the Hype, the First Rate Cut Isn’t a Market Disaster

The current doomsday prediction is gaining traction. Next week, Federal Reserve officials plan to lower interest rates for the first time since our central bank ceased raising them over a year ago. Some pessimists advise selling stocks before the announcement, fearing that the policy change could lead to a significant market downturn because most substantial gains have already been made.

On Wall Street, it’s often said that pessimists may seem wise, but optimists reap the rewards. This statement highlights the contrast between bullish (optimistic) and bearish (pessimistic) investors. Frequently, the skeptics construct compelling, complex narratives to bolster their arguments, rather than analyzing data. Consequently, they overlook the factors that could lead to growth and miss out on market surges.

According to my research findings, it appears that when our central bank reduces interest rates, the stock market doesn’t plummet as one might expect. Instead, it often continues to rise. The increases in this case usually align with the standard long-term trend. This suggests a sustained upward momentum for risky investments such as the S&P 500 Index and cryptocurrencies like Bitcoin and Ethereum over the long term.

But don’t take my word for it, let’s look at what the data’s telling us.

Let me clarify one point before we proceed: I want to ensure you’re clear on the connection between cryptocurrencies and traditional stocks. To put it simply, from the perspective of momentum-driven investors like hedge funds, both are categorized as high-risk assets. As a result, they often move in tandem, either upward or downward.

Money managers consider safe assets as corporate bonds and Treasuries, which are supported by tangible assets or the credibility of the U.S. government. This is significant because in case of bankruptcy, bondholders get their money back before others, while the 14th amendment suggests that our government cannot default on its debt (it has not done so yet).

Both stocks and cryptocurrencies share some similarities in terms of risk, as they don’t offer the same level of protection that other investments might provide. For instance, if a company declares bankruptcy, stockholders are usually at the bottom of the list when it comes to receiving any remaining funds, so their chances of recovering their investment are slim. On the other hand, cryptocurrencies lack government backing, making them potentially risky investments since you could lose your entire investment if things go south. Of course, this doesn’t guarantee that either scenario will happen, but it’s important to understand the risks involved with these types of investments. If you want a better sense of what I mean, check out the returns from 2018 through 2024 for a comparison.

In essence, if we want to truly grasp how factors such as monetary policy impact the stock market, it’s crucial to examine data over an extended timeframe. This approach allows us to accumulate a diverse and representative dataset that encompasses various economic situations. With this comprehensive set of information, we can more accurately discern long-term trends.

An effective method for observing this is by examining the average yearly return of the S&P 500. By gathering data dating back to 1928, we can accumulate nearly a century’s worth of figures.

What initially catches my eye in the chart is the pattern of ups and downs. The green sections represent years with profits, whereas the red ones denote losses. Remarkably, some of these gains are impressive, reaching over 44% in 1933 and an astounding 45% in 1954. Similarly, the drops are equally noteworthy, as the S&P index fell more than 47% in 1931 and over 38% in 1937.

Reflecting on my investment journey in the world of cryptocurrencies, one crucial aspect that catches my attention is the fact that more times than not, I’ve seen gains surpass losses. This pattern stretches back to 1928, where I’ve noted a total of 65 instances where the S&P 500 Index has shown an increase.

Instead of merely continuing the process, let’s delve deeper. Specifically, we’re interested in examining periods following monetary-policy tightening, particularly instances where the Federal Reserve resumes reducing interest rates again. For this analysis, I looked as far back as the 1970s. During that time, our central bank was grappling with high inflation, and to combat it, interest rates had to be raised above 20%.

However, looking back that far allowed me to discover no less than nine instances where the Federal Reserve reduced interest rates. Here’s a table outlining the S&P 500’s overall return (including dividends) following these rate cuts:

On the left side, you’ll find the month and year that the initial rate cut took place. Since the Federal Open Market Committee can meet on different days within a month, I gathered data from the end of each month when the announcement was made. Afterward, I calculated the returns for the 3-, 6-, 12-, and 24-month periods following this date.

At the end, I display the average return across all timeframes. Additionally, I’ve determined the success ratio, which represents the number of instances where the returns were positive.

Examining the data, it appears that following the Federal Reserve’s decision to reduce interest rates, there is a timeframe where a slight drop – approximately 1% – in the S&P 500 occurs. However, this negative return has only been observed four times out of nine instances, which equates to a 56% probability.

In the different time periods, the results seem more persuasive. Specifically, within a span of six months, the market yielded a return of 2.3%, while over a year it returned 6.8%. However, this is slightly lower than the long-term average of 9.5%.

What’s particularly striking is the outcome we observe two years into the rate reduction phase. At this juncture, market growth seems to speed up, yielding an average return of 26.5%, equivalent to approximately 13.2% yearly. Remarkably, this trend has occurred in seven out of our nine case studies.

Essentially, I mentioned earlier that fear is a powerful sales tool. We’re more drawn towards information about potential losses rather than gains, and this fact isn’t lost on those who spread negativity. They understand that by painting a grim picture, they can attract more people to engage with their content.

Based on the data we’ve examined, it appears things might be different from what you think. The first interest rate cut doesn’t necessarily signal an end to gains in risk assets. In fact, if others react with fear, we could potentially benefit from the resulting market selloff. After all, history has shown us that over the next few years, investments such as stocks and cryptocurrencies have a tendency to deliver returns above average.

Please be aware that the opinions shared within this article belong solely to the writer and may not align with those held by CoinDesk Inc., its proprietors, or associated entities.