Fed Rate Cut Sparks Market Rally: Which Sectors Will Lead Next?

Technical Stock Market Briefing for Day & Swing Traders
| By Harry Boxer, Technical Market Analyst

Last week, the Fed delivered what markets had been hoping for and anxiously anticipating.

Interest rates were cut by a larger-than-typical 0.5%, signaling a critical turning point in the monetary-policy cycle.

In response, stocks set new record highs, and the S&P 500 extended its year-to-date gains to near 20%, as investors embraced and applauded the move.

The Dow on Monday eclipsed a record high that it had set in mid-July, while the S&P 500 followed suit on Thursday as stocks were lifted by the first interest-rate cut since March 2020. Each of the major indexes gained around 1.5% for the week, leaving the NASDAQ nearly 4% shy of its historic peak.

The week’s biggest move in the stock market came on Thursday—the day after the Fed’s rate-cut announcement—when the NASDAQ jumped 2.5%, the S&P 500 added 1.7%, and the Dow rose 1.3%.

The last three times the Fed cut rates by 0.5% in a single meeting during an easing cycle was in 2020 in response to the pandemic, in 2008 in response to the financial crisis, and in 2001 in response to the bursting of the tech bubble. This time appears to be different in the sense that the Fed is cutting rates because it can, not because it has to. The larger cut is not in reaction to recessionary conditions but rather as insurance against an unexpected slowdown in employment, with a goal to preserve the economic expansion.

From a market perspective, the lesson from history is that equities’ response to rate cuts depends on the state of the economy.

The start of a rate-cutting cycle that coincides with no recession has historically led to strong stock returns six, 12, and 18 months after the first rate decline. Examples of such instances are the cycles that started in 1984, 1989, 1995, and 1998. However, rate cuts in response to economic weakness and recession have been accompanied by losses, as in 1981, 2001, and 2007.

The last time stocks were at record highs when the Fed implemented the first rate cut of the cycle was in 1995, and the S&P 500 went on to gain 23% in the 12 months after. Historically, valuations have tended to rise after the start of easing. However, because valuations are currently elevated relative to history, the upside in stocks may be more modest than in previous soft-landing cycles.

So far in the third quarter, we have seen a subtle change in market leadership toward more balance than over the past year. While the shift in Fed policy has helped lift stocks broadly, it is a mix of defensive and cyclical sectors that have led the charge (real estate, utilities, financials, industrials), rather than the usual suspects (tech, communication services, and consumer discretionary).

Nasdaq is actually trailing the market-cap and equal-weighted S&P 500 over the past three months. Growth is underperforming value, and semiconductors, a group that has delivered stellar results over the past year, is bucking the market trend and posting modest losses.