Since 1982, the Federal Reserve has cut interest rates 85 times. After the Fed's upcoming meeting in September, that number is expected to rise to 86. The current interest rate range is 5.25% to 5.50%, and the consensus is that the first cut will be just a quarter-point, or 0.25%.

Why now?

The Fed has a dual mandate: to maintain maximum employment and ensure price stability. The chart below shows the U.S. unemployment rate (orange line) and annual inflation rate (green line). Headline inflation seems to be stabilizing for now, with prices rising more slowly than they did in 2021 and 2022. This does not mean, however, that the stuff we buy is getting any cheaper. Unemployment has been ticking a bit higher in recent months, too, rising from 3.5% last year to 4.3%, currently.

The chart below from Macrobond shows recent changes to the Fed funds rate, as well as future expectations based on today’s data, as well as data from the beginning of August and July (the top line).

Rates are now expected to fall quite a bit further and faster than what markets anticipated at the beginning of July.

Should you take any action?

The chart below only includes days where the Fed funds target changed, either upward or downward.

To help answer my previous question, we looked at every instance where the Fed cut rates since 1982 - 85 such days, as noted earlier. Given that the Fed’s next move is likely to lower rates, we focused on those periods circled in orange (mostly), where the Fed was cutting rates.

(Click on the arrows in the bottom right corner to expand the chart.)

Source: Divvi Wealth Management, data from St. Louis Federal Reserve (FRED)

Starting with the day of those rate cuts, we wanted to see how a few widely-owned asset classes performed over the next month, or 22 trading days, to be specific, as well as the next year:

• U.S. stocks, using the S&P 500 as a proxy,

• U.S. bonds, using the Bloomberg US Aggregate Bond Index, and

• Public real estate (REITs), using the FTSE NAREIT All Equity Index.

The summary data is in the table below. Here are a few highlights:

• The median return during the year following a rate cut for U.S. stocks was 12%, with positive returns 74% of the time.

• Bonds performed consistently well, with a median 1-year total return of nearly 9% and positive returns 96% of the time.

• REITs, on average, outperformed stocks and bonds. The median 1-year return was over 16%.

Source: Divvi Wealth Management, data from Morningstar Direct

The data behind that summary table is in the charts below. Orange dots represent the 1-month return following a rate cut, and the green bars show 1-year returns. Use the arrows in the bottom left corner to scroll through.

The first chart is US stocks, then bonds, and finally REITs.

• Stocks struggled in the early and late 2000’s, around the time the tech bubble was bursting and during the global financial crisis. Outside of that, returns seemed generally good.

• Bond returns benefited from higher yields in the 1980s, when 1-year returns were best. But even through the 1990s, 2000s, and 2010s, bonds typically fared very well after a rate cut.

• REITs, unsurprisingly, fell sharply during the global financial crisis. But, like stocks and bonds, REITs typically performed well in the year following rate cuts.

It is important to remember rate changes were just one factor influencing market returns in each of these periods. Our economy is complex and evolves over time. Just because something happened a certain way in the past doesn't guarantee a similar outcome in the future.

With that in mind, here are some steps investors could consider before September.

• Do nothing. That is not sarcasm. If your portfolio is still aligned with your goals, you may want to avoid the temptation to make changes just for the sake of taking action.

• Revisit risks, intentional and otherwise. Consider a portfolio that was invested 10 years ago with the following allocation (see chart below):

  • 75% stocks and REITs (50.6% US stocks, 18.8% foreign stocks, and 5.6% REITs)

  • 25% bonds

  Without any rebalancing, that portfolio would be invested in nearly 90% equity today. Bonds would account for just about half of their original weight.

  The past few years have been among the worst for bond investors since 1980. It could be a good time to revisit fixed income, both in terms of what you own, and for what reasons.

  Dividend paying stocks are another example of a group that has struggled to keep pace with the broader market. Vanguard’s S&P 500 ETF has returned about 240% over the past 10 years, including dividends. The Vanguard High Dividend Yield ETF (VYM) has earned investors just 155% during that same period.

  To put it simply, we are advocates of being intentional with money. Past returns do not need to dictate how we allocate today.

• Rethink cash. With short-term rates expected to fall, the rates we earn on things like high yield savings accounts and money market funds will likely fall as well. If the dollars in those accounts are emergency savings or earmarked for upcoming expenses, the interest rate should be secondary to safety and liquidity. In these cases, no action may be the right action.

  However, for those attracted to a “safe” 5% return, it may be time to consider other alternatives. The New York Times recently published a column discussing the decision savers may face in the months ahead.

The potential for lower interest rates presents both opportunities and challenges for investors. We can observe how markets reacted in similar periods from the past, but future returns are anything but guaranteed. It can be easy to get caught up in short-term market movements. Revisiting financial goals, and how investments are aligned with those goals, can help investors navigate times like this.

Interested in talking more?

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