Time to Read: 7 minutes

On March 3rd, the Federal Reserve announced an emergency rate cut, lowering the federal funds rate by 50 basis points to a range between 1% and 1.25%. In its first intermeeting cut since 2008, the committee noted that the fundamentals of the US economy are still strong but the coronavirus poses evolving risks to economic activity. Despite the Fed’s supportive move, the market reaction was less than stellar with the Dow Jones Industrial Average sinking 785 points on the day. As recently as late February, several Fed officials seemed to push back against expectations of rate cuts—so when the cut materialized, it smelled a little bit like a panic move rather than a preemptive strike, which perhaps explains the market reaction.

Today, US stocks have collapsed even further as drama in the oil market and heightened coronavirus fears are fueling intense selling—enough to trigger “circuit breakers” that halted trading for 15 minutes shortly after the open. Needless to say, the current environment is characterized by high levels of uncertainty.

In this post, we examine historical Fed intermeeting cuts and their impact on stocks, as well as market patterns during times of high uncertainty. We also share three actions we believe investors should consider taking right now.

History lesson: Fed intermeeting cuts and subsequent S&P 500 Index performance

Market performance after past Fed intermeeting cuts has been mixed. Since 1990, there have been 10 intermeeting cuts: Six during recessions and four during expansions. Across all cases, performance of the S&P 500 three months post-cut has been similar. In recession cases, one year later, the S&P 500 has been down an average of 9.1% versus a gain of 5.8% in non-recession cases, as shown below. The one case that had no recession within a year before or after the intermeeting cut was on October 15th, 1998. The S&P 500 was up 23.1% six months later and 19.1% one year later. In summary, intermeeting cuts have historically been bullish for stocks if they prevent a recession.

In times of high uncertainty, it’s a four-step process

As the number of confirmed coronavirus cases continues to increase globally, it’s impossible to predict how many people will be affected or how mitigation efforts may impact the economy. Prospects for a pronounced economic slump and a wider outbreak have led many investors to sell first and ask questions later. Two weeks ago, the S&P 500 suffered its worst weekly decline since the financial crisis in 2008 and the fastest 10% correction ever recorded from an all-time high—a breakneck move from a high to a low.

During times of high uncertainty, markets can be extremely volatile and each circumstance is unique; from a technical perspective, however, markets generally follow a four-step process:

  1. Oversold
  2. Rebound
  3. Retest
  4. Breadth Thrust

The market was clearly oversold by Friday, February 28th and rebounded sharply on Monday, March 2nd, when the 4.6% surge by the S&P 500 was the strongest since December 26th, 2018. The March 2nd rally, though, failed to produce what traditionally is considered a Breadth Thrust, a measure that considers the number of advancing versus declining issues and often signals the start of a new bull market. As shown below, March 2nd was a 7:1 up day (advancing volume was seven times declining volume), falling short of the 10:1 up day that researchers have historically considered an official Breadth Thrust.

We believe the market will likely retest the lows seen February 28th—as it is seemingly doing today—and we will have to see if those lows hold or if new lows will be established. If retests fail, there could be several rounds of steps one through three.

Looking ahead: Sketching out a recovery

Like past crises, this one will pass. It’s difficult to see the other side right now, and virus-related economic disruption may be significant, but the economic impact may be temporary. Based on economic fundamentals, markets appear poised to eventually look forward to better days.

It is important to note that while each correction is different, V-shaped recoveries are rare. Since 1950, the S&P 500 has taken a median of 281 days, or 9.2 months, to roundtrip from a 10% correction, as shown below. It has taken a median of 144 days, or 4.7 months, to recover to breakeven from the trough.

What now? Three actions to take today

First, we believe exercising patience is of the utmost importance. As we have illustrated above, the ultimate recovery will likely be a longer-term process which may be surrounded by negative short-term news cycles. Next, we believe investors should ensure their investments are aligned with their long-term plans and risk tolerance. If invested too aggressively, investors should use the Rebound in step 2 above to lighten up on risky investments. Finally, people should consider reviewing their mortgages and other debts as the Fed’s intermeeting rate cut and declining bond yields have brought mortgage rates to record lows.

The US economy and corporate America are resilient and adaptable. Stocks have weathered wars, natural disasters, terrorist attacks, financial crises, and many other economic and geopolitical shocks. Through it all, stocks have produced a 9% annualized return since 1929, as measured by the S&P 500.

 

Investment advice offered through Stratos Wealth Partners, Ltd., a Registered Investment Advisor DBA Brown Wealth Management

Investing involves substantial risk. Brown Wealth Management and Stratos Wealth Partners (the “Firm”) do not make any guarantee or other promise as to any results that may be obtained from the Firm’s “letter”. While past performance may be analyzed in the Letter, past performance should not be considered indicative of future performance. All indices are unmanaged and cannot be invested into directly. 

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. No reader should make any investment decision without first consulting his or her own personal financial advisor and conducting his or her own research and due diligence.