Be Careful What Rate Cuts You Wish For

“The time has come.”

Of all the words Federal Reserve Chair Jerome Powell uttered at the Jackson Hole conference last week, those four were the only ones that Wall Street seemed to care about. A rate cut is coming in September… and more will follow. 

Now speculation shifts to how much the Fed slashes rates following its September 17-18 meeting… by 0.25% or 0.5%. 

The futures market is splitting the difference, pricing in a 0.32% cut. They’re also pricing in over a full percent in cuts by the December meeting. Given that there are only three Fed meetings left this year, that means Powell will have to cut rates by 0.5% in at least one of them. 

That must mean it’s time to pop the Champagne corks for risk-on and FOMO, right?

Maybe. 

This is a case of “be careful what you wish for.” Because not every Fed cutting cycle looks like the last one.

Let’s flash back to the tail end of the 1990s tech bubble. Given that large-cap tech is again totally dominating the market, this may be the best comparison we have. Let’s see how the world looked once Alan Greenspan started cutting rates in January 2001.

Cuts Didn’t Cut It

Greenspan cut rates by 0.5% on January 3, 2001… and by another 0.5% 0n January 31. He followed this with three more 0.5% cuts in March, April, and May… and two 0.25% cuts in June and August. 

We all know what happened on September 11, 2001, and that had a major impact on stock prices. It also prompted Greenspan to make three more emergency 0.5% cuts on his way to eventually cutting rates to a then unprecedented 1%. 

The biggest terror attack in history obviously skewed the market action, so let’s just look at how the S&P 500 performed in the first eight months of 2001.

S&P 500 January 2001–August 2001

The most generous interest rate cuts in history (up to that point) weren’t enough to stop a market slide of 13%. Of course, this was after the market had already dropped about 15% from its 2000 highs. 

Despite all of Greenspan’s rates slashing, the S&P 500 still lost close to half its value before finally hitting bottom. The tech-heavy Nasdaq Composite lost about 80%.

Even with interest rates at 1%, there was no FOMO, or at least not in the stock market. Speculation moved to the housing market, and we know how well that ended in 2008. 

And speaking of 2008, let’s see how the market responded to the Fed’s aggressive rate cuts then as well. 

Fed Chair Ben Bernanke slashed rates by 0.5% in September 2007… 0.25% in October and again in December… and then monster cuts of 0.75%, 0.5%, and 0.75% on January 22, January 30, and March 18, 2008, respectively. 

None of that stopped the bleeding. The S&P 500 ended up dropping 56% before finally catching a bid in 2009.

S&P 500 September 2007–April 2009

Now, let me be clear. I do NOT expect the S&P 500 to implode like it did in 2000 and 2008. I’m not saying it won’t, of course. But that’s not the point I’m trying to make. 

My point is this: The Fed doesn’t aggressively chop rates unless something is very wrong in the world. 

And when things seem to be falling apart… that’s probably not the best time to be invested. 

Yes, the world was falling apart in 2020, and yes, the Fed’s dramatic rate cuts corresponded with one of the great bull markets of our lifetimes. But there was also a lot more going on than just rate cuts. The Fed injected $5 trillion into the capital markets via quantitative easing. They won’t be doing that again. 

Congress showered Americans with pandemic stimulus that was largely unnecessary given that the vast majority of Americans still had jobs. A lot of that money flooded into the market too… and that won’t be happening again either. 

Meanwhile, there are signs that something isn’t quite right in the real economy… 

A Bellwether Sounding an Alarm

Just this morning news broke that core capital goods orders – an important bellwether for business sentiment – fell last month. 

And consumers aren’t in great shape either. 

I’ve been writing all year that working- and middle-class Americans have been struggling to deal with the aftermath of brutal inflation. But Bank of America reported just last week that “recent commentary from retailers and travel companies suggests the spending backdrop is challenging, even for the high-end consumer.” 

And the post-COVID travel boom also appears to have finally run its course, as the same Bank of America analysts noted weakness among airlines and hotels.

Now here’s where it gets interesting… 

We’re still 70 days away from the presidential election. Polls have been mostly favoring Vice President Kamala Harris, but the betting markets are forecasting a much tighter race. Harris is leading Donald Trump by less than two points in the betting markets after being up as much as 10 points two weeks ago. And just days ago, Trump was actually ahead. 

Why the flip-flopping in the betting markets?

Pennsylvania. 

There isn’t a realistic path to victory for Harris that doesn’t include taking Pennsylvania. And right now, the betting markets have the state at an effective tie. One day it shows Trump as a 0.5% favorite, and the next day it shows Harris winning by the similar amount. 

That’s a razor-thin margin. 

Any significant economic weakness could result in an election shock come November. 

So, are you ready for that? 

Let me be utterly clear that I hate both of these candidates and I consider both utterly unfit for the job. Neither will have my vote. 

But regardless of who you favor, there’s a contrarian bet on the table here, and that’s where the money will be made. I’ll have more details about all that later in the week. Keep your eyes peeled.

To life, liberty and the pursuit of wealth.