Weekly Update: Fed Cuts Rates. What Will Stocks Do?
Good evening, and welcome to this week’s edition of Stealth Trades!
The Fed cut interest rates Wednesday for the first time in 2025, blaming a weaker labor market. A jobs revision earlier this month showed that 911,000 fewer jobs were created last year than previously thought.
If you’re not aware, the Federal Reserve has two jobs which they refer to as a “dual mandate.” Those are to control inflation AND ensure a healthy labor market.
When prices rise and inflation gets out of control, they raise rates to combat it. That is what happened in 2022 which triggered a bear market.
But, when the economy is weak and unemployment is rising, they lower interest rates to stimulate the economy. And that is what happened this week.
Powell and his buddies at the Fed have found themselves in a precarious position…
On the one hand, the economy is slowing, job growth is dwindling, so they need lower rates to fix this
On the other hand, inflation is at 3% – firmly above their 2% target. Historically, the Fed does not cut rates when inflation is this high. In fact, they haven’t done so in more than 30 years. But this week they had no choice. Rate cuts, after all, will only add to the inflationary trend.
The September “dot plot” showing where Fed members see rates landing over the next 2 years shows a definite trend toward more and faster cuts.
So, what does this do to stocks?
If history is any indication, the market goes up from here.
Only 20 times in history has the Fed cut rates with the S&P 500 at all-time highs. And in each of those occurrences, the market was higher 12 months later by an average of 13.9%
Mortgage rates, which had already priced in this week’s 0.25% cut, have actually ticked up since Wednesday.
Below is a chart of 30-year bond yields:
Following the record-setting negative jobs revision, yields came down in anticipation of a September rate cut by the Fed.
After hearing that cut would be 25 bps and not 50, yields came up by 0.10% the following day. So don’t expect lower mortgage rates until we see more cuts.
What we are likely entering now is a period of what’s known as stagflation. This is when you get stagnant economic growth but high inflation.
It’s not a good thing. And investors need to be prepared.
The last time this occurred in the US was in4 1970. Unemployment rates were above average, GDP growth was minimal, but prices were rising faster than usual. So, things got more expensive, but people were not making more money.
Right now, GDP is growing at a 3% clip. This is interesting given the weakening jobs numbers. As you can see below, the unemployment rate has been trending upward for the last 12 months.
My guess is that AI and other new technologies are making American workers more efficient, so even with fewer people in the labor force, they are still able to produce more goods and services.
And the cherry on top?
All of this is happening while stocks are trading at the highest valuations in history.
Using all traditional valuation metrics – P/E, P/B, P/S, Market Cap/GDP – today’s stock market is the most overvalued in history.
This is a dangerous formula…
Strong GDP growth pushes stocks higher. Rate cuts, which we are expecting 4-6 more of over the next year, also make stocks go up. So does inflation which remains above average.
So, unless we see massive productivity growth in the age of artificial intelligence, it is hard to imagine a scenario that does not lead to an epic market crash.
It happened in 1929. It happened in 1999. And it is likely to happen again sometime this decade.
Will we see a crash next year? Unlikely. The data points to higher prices and every macroeconomic factor confirms that trajectory. But it will happen eventually.
Don’t let this scare you. There have been 18 bear markets since 1929, and we have recovered from every one of them. The next will be no different.
When conditions sour and the party comes to an end, we will let you know. Until then, put your foot on the gas, make some money, and let’s party like it’s 1999.
Best wishes for your trading,
