By William Watts, MarketWatch
This is an updated version of an article originally published on July 15.
Investors are puzzling over the apparent paradox presented by the combination of stocks trading at or near all-time highs and a Federal Reserve that appears ready to deliver an imminent rate cut.
A look back at history shows that the Fed has been willing to cut rates with stocks at or near all-time highs in the past, but it’s a phenomenon that hasn’t been seen in more than 20 years. Market analyst Charlie Bilello noted earlier this month on Twitter that since the Fed started targeting the fed-funds rate in 1982, it has delivered rate cuts with the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.05% at an all-time high seven times — the last such cut occurring in January 1996.
Fed-fund futures show traders see a 100% probability of a rate cut Wednesday. Meanwhile, the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.05% and the Nasdaq Composite /zigman2/quotes/210598365/realtime COMP +0.11% ended Tuesday 0.4% and 0.7%, respectively, below all-time closing highs set last week. The Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.11% finished Tuesday just 0.6% off its record close set July 15.
Ryan Detrick, senior market strategist at LPL Financial, which has around $684 billion in advisory and brokerage assets, found that the Fed cut rates 17 times since 1980 when the S&P 500 was within 2% of its all-time high. He also observed that the index was higher a year later all 17 times, with a median gain of 10.4%.
The first ‘insurance’ cut?
Of course, as the old saying goes, the stock market is not the economy. But, as Bilello noted, a rate cut at the July meeting would mark the first time the central bank has ever lowered rates with the unemployment rate, which stood at 3.7% in June, running below 4%.
So, if the Fed does follow through on overwhelming expectations, it might mark what Jeffrey Schulze, investment strategist at ClearBridge Investments, which has around $142 billion in assets under management, argued would be the first true “insurance” cut by policy makers.
While a number of investors and analysts have described easings in 1995 and 1998, when rate cuts were not followed by recessions, as past insurance moves, Schulze noted that in those cases, the Fed moved after a drop in the Institute for Supply Management’s manufacturing gauge to a reading of less than 50, which signals a contraction in activity.
“If the Fed actually does the cut in July this year, I think this will be the first insurance cut, if you will,” Schulze said, in an interview earlier this month.
The ISM manufacturing index has been under pressure, falling to 51.7% in June and signaling the slowest pace of expansion for the sector in more than two years. Powell cited the fall in the indicator as he highlighted worries about the economic outlook in his congressional testimony last week.
Some market watchers have tied the Fed’s aggressively dovish tilt to President Donald Trump’s steady stream of criticism of the central bank and Powell. Trump has argued that the Fed’s previous rate increases have left the U.S. economy at a disadvantage and has said policy makers should cut rates and resume quantitative easing.