Countdown to Rate Cuts, Markets feeling a September shift?

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

After two strong weeks, the major U.S. stock indexes have recovered almost all of the ground lost during a stretch of elevated volatility in late July and early August.

At Friday’s close, the S&P 500 was within 0.58% of the record high that it reached in mid-July, while the Dow was just 0.06% shy of the historic peak that it reached last month. The NASDAQ was 4.13% below its record.

The prospect of lower borrowing costs for smaller companies sparked a rally for small-cap stocks in the wake of Friday morning’s speech by U.S. Federal Reserve Chair Jerome Powell, who raised expectations for interest-rate cuts beginning next month. The small-cap Russell 2000 Index jumped more than 3% for the day versus gains of around 1% for large-cap indexes.

The price of U.S. crude oil last week briefly fell to its lowest level in more than six months, sinking to $71.46 per barrel. Although the price rebounded over the following two days, oil fell overall for the week, trading below $75 on Friday afternoon versus around $77 a week earlier.

Traditionally, the Fed starts cutting rates in response to an economic downturn, a financial shock/crisis, or both. The conditions are somewhat unique this time, as the Fed is not seeking to address a collapsing economy or arrest a seizing financial system. The Fed often cuts rates to press on the gas pedal, stimulating a sputtering economy.

This time it looks like the upcoming rate-cutting cycle is more about easing off the brake, upon which the Fed has had its foot firmly pressed for the last two years.

Certainly, a phase of monetary-policy easing should be a tailwind for financial markets over the next several months. That said, this has been widely and eagerly anticipated, so a portion of that benefit has already been discounted into the stock and bond markets. Short- and longer-term yields have declined notably this year, reflecting expectations for a lower Fed policy rate. Meanwhile, the stock market has returned nearly 40% since interest rates peaked last October.

However, the benefits of lower rates likely have not been fully exhausted for the stock market. The ability for the Fed to lower rates in a manner that orchestrates a soft landing for the economy (avoiding recession) should provide room for corporate profits to rise at a healthy clip next year, which we believe would be a fuel source for this bull market to extend this year and into 2025.

Looking back over the last 40 years at prior initial Fed rate cuts, stock-market performance in the ensuing few months has been generally positive, with all but two instances seeing stocks rise in the following three months. Looking at periods like 1987, 1995, and 1998, when rate cuts were not accompanied by an ensuing recession, returns in the following one to two years were particularly strong.

Lower rates should also be supportive of stock-market valuations and higher returns.

This has been demonstrated by the broader performance of equities in the one and two years following the commencement of rate cuts.

In any case, closely monitor the technicals and “Trade What You See, Not What You Think”