Additional content provided by Colby Hesson, Analyst, Research.

The day has finally arrived. After the clear message from Federal Reserve (Fed) Chair Jerome Powell at last month’s Jackson Hole Economic Symposium that “The time has come for policy to adjust” and several strong hints from various other sources directly or indirectly connected to the Fed, today is almost certainly the day the Fed will embark on its first rate-cutting campaign in more than four years. For those who want to continue the debate over how big of a cut we will get right up until the last minute, the latest odds of a half-point cut based on the bond market (fed funds futures to be specific) sit near 65%.  

We’ll leave the in-depth discussion of what the Fed is or isn’t thinking to the professional Fed-watchers and fixed income strategists out there (including our own Dr. Jeffrey Roach, chief economist, and Lawrence Gillum, chief fixed income strategist). Here, we want to focus on how the various equity sectors might perform once the cutting begins. 

Remember that a few weeks ago we wrote a blog titled“What Does a Rate Cut Mean for Stocks and Bonds?” about how stocks and the 10-year Treasury have historically performed after initial rate cuts (which we are about 99.9% sure we will get today). For this blog, we completed a similar analysis but focused on equity asset classes (growth/value) and sectors. 

Growth / Value Performance 

First, on equity style, we find slightly better performance from the growth style after previous initial rate cuts, but the answer is somewhat nuanced. 

Some observations: 

• On average, value stocks slightly outperformed their growth counterparts three and six months after the initial cut, but growth outperformed 12 months later.  
• Growth was the center of the market collapse in 2001 and 2002, while value was at the epicenter of the 2008 Global Financial Crisis, making those periods less comparable.  
• The 1995 cycle seems most analogous to where we are currently. During the 12 months after that cut, growth was slightly better, but value had an edge over the first six months. 
• Some of the factors at play in 1995 included greater funding availability, which supported growth stocks; steady economic growth, which supported cyclical (economically sensitive) value stocks; and the early stages of the internet buildout, which helped the growth style.  
• The 2019 period is a reasonable comparison for the first few months until the initial breakout of COVID-19 in the spring of 2020. Growth held a slight advantage during that period.  

Outside of 2001, Growth Generally Performed Better After Initial Rate Cuts

Source: LPL Research, FactSet 09/18/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly.  

Sector Performance 

Next, let’s review how stock sectors performed after the previous initial Fed rate cuts. We only have four instances to compare since the 1990s, when the S&P Global Industrial Classification Standard (GICS) sector classifications were created, so be wary of the small sample size. Still, we think this history is worth keeping in mind. 

Some observations: 

• Defensive sectors tended to outperform in the six months after the initial rate cuts. This was particularly evident during the comparable 1995 period that included a soft landing and technology buildout. Healthcare and the defensive telecom services sector (before digital media was added in the sector’s revamp) were top performers, while consumer staples and utilities also outperformed. (LPL Research upgraded healthcare to neutral this month, is neutral consumer staples, and recommends overweighting communication services.) 
• Financials fared well during the 1995 cycle and performed roughly in-line in the 2019 period, more comparable than 2001 when technology dragged the broad market lower and 2007, when financials were at the epicenter of the 2008–2009 financial crisis. (LPL Research maintains a neutral rating on financials, though the re-steepening of the yield curve is a positive development, all else equal.) 
• Surprisingly, the technology sector underperformed the S&P 500 after the 1995 rate cut, even though the internet buildout was in its early phases. Netscape’s initial public offering came shortly after the rate cut in August 1995, which gives you a sense of what was going on at that time. (Netscape is credited with creating the first internet browser.) The takeaway here is that the technology sector, which as we know, is in a major buildout phase now with artificial intelligence, may not get a performance bump from a more accommodating Fed. (LPL Research’s technology sector stance remains neutral). 
• Consumer discretionary has been one of the weaker performers six months post-cut, trailing consumer staples by a wide margin in three of the four cycles and only outperforming in 2001 when, again, technology dragged the market lower. (LPL Research maintains its underweight recommendation on consumer discretionary.) 

Defensive Sectors Generally Outperformed During Previous Fed Rate-Cutting Cycles  

Sector Relative Performance vs. S&P 500 Six Months After Initial Rate Cut 

Source: LPL Research, Strategas 09/18/24
Disclosures: Past performance is no guarantee of future results. All indexes are unmanaged and can’t be invested in directly. 

Summary

Today’s near-assured rate cut will be the first for the Fed in over four years. While a soft landing is still viable, concerns that the Fed may still be behind the curve, coupled with policy uncertainty surrounding the upcoming presidential election, set stocks up for a potentially volatile fall.  

LPL’s Strategic and Tactical Asset Allocation Committee (STAAC) maintains its neutral stance on equities with a slightly negative bias in the very short term based on the technical setup near record highs on the S&P 500, historical seasonal weakness, and political and geopolitical uncertainty. The Committee expects volatility to remain elevated in the coming months as the market waits for more clarity on the economy, fiscal policy, and a better seasonal setup. Historical outperformance by defensive sectors after the Fed starts cutting rates helps shore up the outlook for consumer staples, healthcare, and utilities, though these sectors have outperformed over the past three months and may be due for a pause. 

Within fixed income, the STAAC recommends an up-in-quality approach with benchmark-level interest rate sensitivity.