Why a Rate Cut Could Tank the Stock Market

For months, one of the key arguments the bulls have used for thinking that the stock market should keep on rallying in the second half of 2024 and beyond has been the thought that the Fed is close to cutting interest rates.  We, on the other hand, have been saying that history tells us that these would very likely be bearish developments. 

Despite what so many pundits say on Wall Street, lower interest rates are NOT a bullish sign for the stock market…when they follow a significant tightening cycle (like the one we went through in recent years).  It's one thing when rates come down due to lower inflation, but it's another thing when it takes place due to a meaningful slowdown in growth.  When the latter happens, it is NOT good for a stock market…especially one that is very expensive (like it is today).  Slower growth means lower earnings…and lower earnings mean a lower stock market (especially if it's an expensive stock market).  This will be the case…even if the "slower growth" does not push us into a recession.  (If it DOES push us into a recession, it will be EXTREMELY bearish.)

Looking Forward: Yes, it was great to see last week that the GDP growth in Q2 was higher than the consensus was looking for (2.8% vs. the 2.0% estimate).  However, there is a reason that the GDP reports almost never have much impact on the markets.  They're about as backward looking as any data point economists look at on a regular basis.  So, it was not a surprise that the Treasury market and stock market both ignored that report on Thursday…and moved lower.  However, we're getting a lot of evidence from forward looking information…like the guidance from many consumer-related companies (like Visa, Ford, American Airlines, Nestle, McDonalds, UPS, Coca Cola…and even BofA)…that the consumer is really beginning to pull in their horns……We also see the data on credit card balances that are past due…which have reached their highest level since 2012.  On top of this, the housing market is showing some real signs of weakness.  So, there is no question that there are concerns about growth in the US going forward.

On top of all this, we have the former Fed NY Fed President Bill Dudley penning an article that came out last week…saying that the Fed should cut interest rates at next week's July meeting.  This is a big change for him…and former Fed officials (especially former NY Fed Presidents…who are EXTREMELY influential) do not write pieces like that lightly.  If he is seeing something that tells us that the Fed needs to be more aggressive, it's something we should all take note of.  Heck, Mr. Dudley finished his piece by saying, "Although it might already be too late to fend off a recession by cutting rates, dawdling now unnecessarily increases the risk."  So, it doesn't seem like this extremely influential person is overly bullish on the economic outlook right now.

As we've said many times, if the stock market was trading at 15x or 16x forward earnings, we'd be signing a different tune.  However, as the charts we have provided below (and provided several times in recent weeks), it shows that when interest rates/bond yields roll-over after a significant rise…at a time when the stock market was expensive…it has been very, very negative for stocks…..So, investors need to be careful about what they wish for when it comes to lower short-term interest rates from the Federal Reserve.

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Image from Midjourney