When This Happens, The Stock Market Goes Up 100% Of The Time

The market expects a Fed rate cut soon as the stock market pushes to new highs. Today’s headlines:

  1. Fed rate cut
  2. AAII sentiment
  3. Volatility of volatility
  4. Using copper to trade stocks
  5. Are bonds and interest rates reversing?

For reference, here’s the random probability of the U.S. stock market going up on any given day.

 

Fed rate cut

The Fed will probably cut interest rates this month, even though the stock market is at all-time highs and the economy is not in a recession. This prompted an article from CNBC and Fundstrat:

 

 

 

I decided to look at the data myself because this stat is a little flawed. The article only points out the cases that were followed by economic expansions that lasted at least another year. It ignores the historical cases in which a recession followed within the next few months.

The flaw is simple

You cannot know if a Fed rate cut will be followed by an economic expansion without 20/20 hindsight. This is like saying “if the economy is good after a rate cut, stocks will go up 100% of the time!”

Instead, I decided to look at every single rate cut that occurred when the economy was not in a recession at the time of the rate cut.

 

The S&P’s forward returns were not “100% bullish”. Sometimes the Fed would cut rates, and a recession would start a few months later.

There’s another problem with using “recession” or “no recession” to filter rate cuts. A “recession” is officially defined by the NBER a long time after which it has already occurred. For example, the NBER officially declared in December 2008 that a recession had started in December 2007, 1 year after the recession had started. Clearly, waiting for an official “recession” is useless in real-time.

A better way to filter rate cuts is to use a more real-time indicator, like the Unemployment rate. Here’s every single case in which the Fed cut rates, while the economy is strong (i.e. unemployment is under 5%).

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