The long-awaited interest rate cut is here.
Earlier last month, the US Federal Reserve reduced interest rates by half a percentage point, a larger-than-expected cut.
The move seemed to take the stock market by surprise.
Amid the euphoria, some have started to wonder whether the big rate cut was made to head off an economic slowdown. Of course, it doesn’t help that we are in the middle of a US Presidential election cycle either.
Opinions, as they stand, are a dime a dozen.
So, what’s actually happening here?
Are we headed for a recession?
If so, will the stock market suffer as a result?
Thankfully, we have historical statistics to put things into context.
Where to next, Mr. Market?
We’ll start with the good news.
As a background, based on data compiled by Josh Brown, the CEO of Ritholtz Wealth Management, there have been 21 instances since 1957 where interest rate cuts were made.
The average return of US stocks in the 12 months that followed was 9%.
For clarity, these returns here are based on the gains of the S&P 500.
What’s more, there were only five instances out of the 21 where the stock market ended up in the red one year after the rate cut.
Put another way, the odds of a positive return is 76% after a year — it’s as good as you can get.
Wait, but what if a recession happens during this period?
How will the returns and odds change?
As it turns out, it’s not much.
There were 13 instances where a recession occurred after a rate cut.
Surprisingly, despite the economic downturn that followed, the average return was 8%, fairly close to the average above. In addition, the odds of a positive return during these 13 instances held up well at close to 70%.
That’s pretty good, isn’t it?
Well, there’s more to consider.
When averages lie
While the returns and odds look good, what the averages don’t tell you is the range of outcomes.
Case in point: the 12-month return has varied between a high of positive 34% to a low of negative 36% — the average in this case, which is 9%, does not come close to capturing the possibilities that could happen after an interest rate cut.
As my co-founder David Kuo puts it, putting one hand in the freezer and the other on a hot stove does not give you the average “warmth” you were hoping for.
That’s not all.
Stocks can be volatile during a positive year too.
For instance, in March 1970, the stock market returns a year after interest rate cuts was 11%. However, during the 12 months, the maximum drawdown was a gut-wrenching fall of 23%.
Said another way, to achieve a positive return, you have to endure a gut punch along the way.
So, what do all these statistics tell you?
As you catch your breath, we have a couple of thoughts:
- To get positive returns, you have to accept the risk of getting negative returns after 12 months albeit it being a lower possibility.
- Even when you get a positive return, you have to endure the volatility along the way.
Right, but what should you do again?
Get Smart: The final statistic
Do you know what’s the most interesting thing about the statistics above?
Here’s a hint: it’s not too different from any other year in investing.
According to data from JP Morgan (NYSE: JPM), from 1980 to 2023, the S&P 500 delivered positive returns in 33 out of these 43 years.
For the math geeks, that’s a win rate of over 76%, similar to the win rate above.
But wait, here’s the kicker.
There hasn’t been a single 20-year period since 1950 where the stock market has seen negative returns.
The best time to start is now, so don’t hesitate.
If you have some spare cash, consider investing some of it in the stock market and then slowly add more over time.
Over years and decades, it can grow to a substantial amount and help you to better enjoy your retirement.
Looking to start investing? Our beginner’s guide will show you how to make the best buying decision and make fewer mistakes. Click here to download for free now.
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Disclosure: Chin Hui Leong owns unit trusts that track the S&P 500 but hasn’t added to them since 2009. Today, the majority of his money is in individual stocks.
