How the Market Tends to Perform After Interest Rate Cuts

Everyone is always curious as to how the stock market tends to perform after there have been sizable cuts to interest rates. Interest rate increases are done to slow down an economy and prevent inflation; interest rate cuts are done to revitalization an economy and help encourage economic growth.

So, if interest rate cuts encourage economic growth, then you would think that this would have a positive impact on the stock market shortly after a rate cut. You would be right. Let's look at four different instances when the Fed cut rates in the USA, and the effect that it had on the S + P 500 in the few short months after the cuts.

Let's take a look at four instances when the Fed aggressively cut rates: 1986, 1995, 1998 and 2001. In all but one of the cases, the stock market moved aggressively higher. The only time that the market continue to trade lower was 2001, and you could argue that this was an exceptional case due to 9/11 and the continued deflation of the "Internet bubble."

In 1986, the S + P 500 finished 27.31% higher exactly one year after the first rate cut.

In 1995, the S + P 500 finished 18.67% higher exactly one year after the first rate cut.

In 1998, the S + P 500 finished 20.91% higher exactly one year after the first rate cut.

In 2001, the S + P 500 finished 13.52% lower exactly one year after the first rate cut. Again, this would bring us to January 2002, just a few short months after 9/11, so that data in 2001 is a bit corrupt and useless.

With the Fed now aggressively cutting rates again in 2007, does this mean a much higher stock market in 2008? Historical stats would seem to tell us so. I think that there is a good chance of this occurring again, due to the fact that much of the subprime mortgage damage has already been inflicted on the stock market. Lower interest rates will spur economic growth in the US, and the markets should continue to spin higher.

Filed under: Stock Market Education | General Knowledge