What’s next for US markets and the economy after…

This was a major event, but not a surprise. The market knew this was coming, and asset prices—stocks, bonds, and everything in between—had already adjusted accordingly. This is how markets often work, effectively pricing expected outcomes long before they occur.

That probably started in July, when small-cap stocks had their best month of performance in two decades, driven by anticipation of the Fed’s plan to cut rates. Another notable example is the 30-year mortgage rate, which was 7% in July and has since fallen to 6.2%. The same trend is evident in the 10-year Treasury yield, which was at 4.4% in July and is now near 3.7%.

In short, the market had already done much of the Fed’s work for this. This is something to keep in mind when thinking about what might come next or working with clients to properly contextualize the situation.

In a recent episode of Strange batches podcast, Pimco Chief Investment Officer Dan Ivascyn discussed this topic and was forthright in his assessment of what it means, stating:

“If you have a three- to five-year time horizon, that’s really noise,” while adding, “it’s less important than people think it is.”

Of course, reasonable people can disagree. Stating the obvious: rising rates versus falling rates is a completely different market environment. As Warren Buffett himself said, interest rates act like gravity on asset prices, which means it matters.

Ivascyn also added that his executive team, along with former Fed Chairman Ben Bernanke — now a Pimco adviser — sits in a conference room during Fed press conferences, looking for subtle shifts in tone and language. Any notable developments could influence the way they trade and position their portfolios.

But for financial advisors discussing this topic with clients, the most important question may be: What do rate cuts tell us about the future? The answer: for those with a time horizon beyond a few years, it’s often just noise.

Data from Ned Davis Research shows that stocks have historically performed well in the 12 months following the first rate cut. Since 1974, stocks have been positive 80% of the time, with an average return of 15%.

Stocks and Rate Cuts (S&P 500 Forward Returns After Rate Cut)

Source: Ned Davis Research, Patient Capital, Bloomberg. Past performance does not guarantee future results. Investments cannot be made directly in an index.

However, investing can always be a funny game of caveats or “well, actually.” This might come in the form of, “Well, actually, returns are much worse if a recession hits.”

This is true; however, the sample size is much smaller. In a recession, returns one year later are positive only 33% of the time, with the average return negative at 8%.

Stocks, Rate Cuts, and Recessions (S&P 500 Forward Returns After Rate Cuts + Recession

Source: Ned Davis Research, Patient Capital, Bloomberg. The data excludes the easing cycles of 1974, 1980 and 1981 because recessions were already underway when the Fed initially cut. Past performance does not guarantee future results. Investments cannot be made directly in an index.

But if you reverse this analysis, focusing only on periods when the Fed cuts rates without a recession, the results change dramatically. Stocks are positive in every period, with an average return of 22% one year later.

Stock, Rate Cuts and No Recession (S&P 500 Forward Returns After Rate Cuts + No Recession)

Source: Ned Davis Research, Patient Capital, Bloomberg. Past performance does not guarantee future results. Investments cannot be made directly in an index.

Which scenario is more likely – recession or no recession – remains open to debate. Depending on your view, you can find compelling data to support either scenario.

Anecdotally, the financial strain on lower-income consumers is becoming apparent, which could foreshadow more economic cracks. Companies like Dollar General and Ally Financial, which serve the most cost-sensitive consumers, have highlighted these concerns.

There is also the impact of how aggressive the Fed was with its first rate cut, opting for a 50 basis point cut instead of the usual 25 basis point cadence during the hiking cycle. Perceptions matter, and this can give many people the impression that the Fed is concerned about the economy.

On the other hand, the world’s largest and most profitable companies are investing at the highest levels in recorded history, driven by expected productivity gains from artificial intelligence and other innovations. This surge in investment from the world’s most successful companies seems at odds with a recession.

While you can try to split the proverbial atom over which economic scenario is more likely, a simpler approach rooted in a basic investment truth is this: expanding your investment time horizon increases the likelihood of success.

The author(s) do not own shares in any of the securities mentioned in this article. Learn about Morningstar’s editorial policies.