Since 1971, the U.S. has witnessed nine major rate-cutting cycles (12 if we take into account interim adjustments in 1973 and 1980). These cycles have varied greatly, influenced by the evolution of U.S. monetary policy. In the 1970s and 1980s, sharp rate hikes and cuts were the norm—during 1980-81, rates were near all-time highs three times. In contrast, the Federal Reserve's approach in the 1990s and 2000s shifted towards a more balanced strategy, with gradual rate adjustments. Today's tightening cycle mirrors characteristics with both the 1970s and 1980s (rapid rate hikes) and the 1990s and 2000s (rates were held at or close to terminal levels for extended periods).
Source: FactSet, Freedom Broker analysis
A key determinant of the impact of Fed rate cuts on the market is the subsequent onset or avoidance of a recession. As illustrated, seven out of nine easing cycles led to a recession in the U.S. Notably, recessions were avoided in 1984 and 1995 (and 1998, if considering intermediate cycles), while the 1989 easing led to a recession with a significant lag (approximately one year). It is important to note that the last four recessions were triggered by external shocks: short-term oil shock in 1990, the dot-com bubble in 2000, the mortgage bubble in 2007 and Covid-19 in 2020. This suggests that while high interest rates may create a conducive environment for negative shocks, high interest rates are not the sole generating factor. The question remains whether the recent recessions would have occurred without these specific shocks.
Given the critical role of recessions as a market variable, let's examine notable patterns or red flags associated with or confirming a recession. It is crucial to remember that no single recession indicator should be viewed in isolation due to the complexity of the economy and the unique characteristics of each recession.
One of coincident indicators of recession which also could act a proxy on consumer health is a consumer sentiment from the Conference Board. During the 2001 and 2008-09 recessions, consumer sentiment served as a leading indicator.
Source: FactSet, Freedom Broker analysis
Another proxy for consumer health and spending readiness is the trend in consumer expenditures on durable goods (expenditures on durable goods are more elastic compared to nondurable goods and services expenditures). Like the previous indicator, consumer spending on durable goods tends to shrink during recession periods and can act as a coincident recession indicator. Currently, there are no significant signs of a decline in durable goods spending, despite consumer credit interest rates being at their highest level since 1996, according to data from the Federal Reserve.
Source: FactSet, Freedom Broker analysis
Worth noting that despite recent triggering of the Sahm Rule, the U.S. labor market remains relatively strong, with the economy continuing to generate jobs. The slowdown in job creation can be attributed to the normalization of the labor market—economic conditions are near full employment, with unemployment near local lows and the growth of Initial Jobless Claims remaining relatively low. Shown in the chart below, U.S. recessions over the past 70 years have always been accompanied by a negative trend in the three-month average of Nonfarm Payrolls.
Source: FactSet, Freedom Broker analysis
Based on previous cycles, common recession red flags include declines in pre-tax net margins and increases in net interest expenses (as shown below), which contrast sharply with the current cycle. The difference in the current situation is partly due to US companies successfully refinanced part of the debt at lower rates during 2020-21 and the subsequent rise in interest rates in 2022-23 boosted current interest income. This pattern may suggest that economic agents have sufficient resilience for a potential soft landing in new future.
Source: FactSet, Freedom Broker analysis
*As a proxy for margin calculations, we used: Flow of Funds, Nonfinancial Corporate Business, Revenue from Sales of Goods and Services (excluding indirect sales taxes), and Nonfinancial Corporate Business Profits Before Tax (excluding IVA and CCAdj), based on BEA data and FactSet.
**As a proxy for interest coverage calculation, we used: Gross Value Added of Nonfinancial Corporate Business, Net Operating Surplus and Gross Value Added of Nonfinancial Corporate Business, Net Operating Surplus, Net Interest and Misc. Payments, based on BEA data and FactSet.
Source: FactSet, Freedom Broker analysis
We are not advocates of complacency or rose-colored glasses, but assessing the overall economic picture, we do not see conditions that would indicate an imminent recession (though we must remember that recent recessions were triggered by external factors, so we cannot rule out a negative scenario).
Let's examine market patterns following the onset of Federal Reserve rate cuts.
Sector and factor performance three months after Fed Funds Rate cut
| S&P 500 | Energy | Materials | Industrials | Consumer Discretionary | Consumer Staples | Health Care | Financials | IT | Communications | Utilities | Real Estate | |
| 07/07/1995 | 5% | 0% | -4% | 1% | 0% | 8% | 17% | 12% | 0% | 14% | 4% | |
| 02/10/1998 | 22% | 0% | 3% | 20% | 31% | 20% | 15% | 24% | 46% | 23% | 0% | |
| 05/01/2001 | -11% | -4% | -6% | -9% | -6% | -3% | -5% | -8% | -28% | -10% | 7% | |
| 21/09/2007 | -4% | 0% | 0% | -4% | -11% | 5% | 1% | -15% | 1% | -6% | 6% | -14% |
| 02/08/2019 | 3% | -2% | 2% | 4% | 2% | 3% | 1% | 4% | 5% | 2% | 7% | 4% |
| Median | 3% | 0% | 0% | 1% | 0% | 5% | 1% | 4% | 1% | 2% | 6% | -5% |
| Russell 1000 Growth | Russell 1000 Value | MSCI USA Quality | S&P 500 Low Volatility | S&P 500 Dividend Aristocrats | Russell 2000 | Russell Midcap | GOLD | |
| 07/07/1995 | 6% | 5% | 5% | 7% | 5% | 7% | 5% | 0% |
| 02/10/1998 | 29% | 15% | 27% | 16% | 16% | 17% | -3% | |
| 05/01/2001 | -19% | -4% | -12% | 2% | -1% | -3% | -6% | -4% |
| 21/09/2007 | 0% | -7% | -1% | -3% | -7% | -7% | -4% | 7% |
| 02/08/2019 | 3% | 3% | 4% | 3% | 5% | 2% | 2% | 5% |
| Since 1995 | 3% | 3% | 4% | 3% | 5% | 2% | 2% | -2% |
Source: FactSet, Freedom Broker analysis
Sector and factor performance six months after Fed Funds Rate cut
| S&P 500 | Energy | Materials | Industrials | Consumer Discretionary | Consumer Staples | Health Care | Financials | Information Technology | Communication Services | Utilities | Real Estate | |
| 07/07/1995 | 11% | 13% | -3% | 10% | 3% | 18% | 29% | 15% | -8% | 25% | 13% | |
| 02/10/1998 | 29% | 2% | 5% | 27% | 47% | 8% | 22% | 31% | 65% | 31% | -10% | |
| 05/01/2001 | -8% | -2% | 3% | -1% | 0% | -6% | -7% | -4% | -25% | -13% | 3% | |
| 21/09/2007 | -13% | -8% | -7% | -9% | -16% | 1% | -11% | -23% | -14% | -22% | -7% | -11% |
| 02/08/2019 | 10% | -9% | 1% | 7% | 6% | 6% | 10% | 9% | 21% | 9% | 15% | 4% |
| Median | 9% | -2% | 1% | 7% | 3% | 6% | 10% | 9% | -8% | 9% | 3% | -4% |
| Russell 1000 Growth | Russell 1000 Value | MSCI USA Quality | S&P 500 Low Volatility | S&P 500 Dividend Aristocrats | Russell 2000 | Russell Midcap | GOLD | |
| 07/07/1995 | 10% | 12% | 10% | 16% | 12% | 8% | 7% | 3% |
| 02/10/1998 | 40% | 17% | 34% | 14% | 14% | 20% | -7% | |
| 05/01/2001 | -16% | -1% | -10% | 8% | 5% | 4% | -1% | -1% |
| 21/09/2007 | -11% | -15% | -10% | -11% | -16% | -14% | 26% | |
| 02/08/2019 | 13% | 6% | 13% | 8% | 7% | 5% | 7% | 10% |
| Since 1995 | 10% | 6% | 10% | 8% | 7% | 5% | 7% | 3% |
Source: FactSet, Freedom Broker analysis
According to FactSet data (based on median industry index performance since 1995), sectors showing the best performance over a three-month horizon include Utilities (+6.1%), Consumer Goods (+5.4%) and Financials (+3.9%). Among investment factors, high dividend yields (+4.8%) and quality (+3.9%) performed best over the same period. Over a six-month period following the initial rate cut in a cycle, top-performing sectors were Healthcare (+9.6%), Communications (+9.5%) and Financials (+8.6%). The best investment factors during this timeframe were Quality (+10.3%) and Growth (+10.2%).
If we extend the analysis to longer periods (since 1973), using the average performance of companies within each sector as a proxy, the conclusions are similar: the beginning of an easing cycle tends to have the most positive impact on the Consumer Discretionary, Health Care and Financials sectors. But it's crucial to consider the broader market context when analyzing these patterns. For instance, the rate cuts in 1998 contributed to the dot-com bubble, with the IT sector surging 65% within six months. However, the collapse of bubbles in 2001 and 2007 led to declines of 25% and 14% of the IT index, respectively, over the same period. Also it is important to mention that over the past decades, the structure and business models of various sectors have evolved. Notably, the IT sector has undergone significant changes, transforming from a highly cyclical industry into a mix of subscription-based businesses and consumer solutions providers, with characteristics similar to consumer goods (e.g., smartphones).
On average, the S&P 500 index increased by 15.4% during periods when a recession did not start within six months of the first rate cut. However, if a recession began within six months, the average decline in stock prices was 7.4%.
Sector and factor performance six months after Fed Funds Rate cut
| S&P 500 | Energy | Materials | Industrials | Consumer Discretionary | Consumer Staples | Health Care | Financials | IT | Communications | Utilities | Real Estate | |
| 07/09/1973 | -7% | -1% | 7% | -8% | -15% | -10% | -11% | -4% | -9% | -33% | -8% | -9% |
| 26/07/1974 | -11% | -8% | -10% | -13% | -11% | -3% | -4% | -9% | -31% | -15% | 5% | -18% |
| 04/04/1980 | 27% | 47% | 31% | 27% | 52% | 24% | 40% | 18% | 51% | 30% | 3% | 11% |
| 30/01/1981 | 1% | -10% | 4% | 8% | 16% | 10% | 2% | 13% | -9% | 12% | 4% | -4% |
| 19/06/1981 | -6% | -8% | -17% | -12% | -9% | -2% | -6% | -3% | -23% | -18% | -1% | -9% |
| 07/09/1984 | 9% | 0% | 10% | 12% | 18% | 12% | 14% | 30% | -16% | 15% | 13% | 21% |
| 09/06/1989 | 7% | 23% | 5% | 1% | -5% | 19% | 10% | 8% | -14% | 7% | 8% | -6% |
| 07/07/1995 | 11% | 13% | 4% | 12% | 4% | 10% | 32% | 16% | -14% | 12% | 13% | 4% |
| 02/10/1998 | 29% | -1% | 12% | 18% | 40% | 12% | 13% | 20% | 70% | 33% | -16% | -6% |
| 05/01/2001 | -8% | 0% | 2% | 2% | 15% | 1% | 10% | -2% | -4% | -5% | 10% | 8% |
| 21/09/2007 | -13% | -5% | -15% | -12% | -16% | -7% | -10% | -14% | -14% | -19% | -9% | -7% |
| 02/08/2019 | 10% | -10% | 1% | 10% | 8% | 6% | 9% | 9% | 16% | 4% | 14% | 5% |
| Since 1973 (no recession) | 15.4% | 11.7% | 10.3% | 13.5% | 19.4% | 13.8% | 19.6% | 17.0% | 15.6% | 16.9% | 5.9% | 4.9% |
| Since 1973 (recession) | -7.4% | -5.4% | -4.9% | -5.7% | -3.4% | -1.8% | -2.9% | -3.2% | -15.2% | -13.0% | 0.2% | -6.6% |
*The table should be viewed as a proxy for sector performance differentials, not as actual sector returns. This is because the calculation uses the median price movement of companies within each sector, rather than the weighted actual value of the sector index. Additionally, the use of currently existing companies introduces survivorship bias, which distorts the figures.
"No Recession" refers to a scenario where no recession occurs within the 6-month period following the first Fed Funds Rate cut.
** Кed fill — recession periods within the 6-month period
Source: FactSet, Freedom Broker analysis
Overall, we conclude that the U.S. economy continues to grow. Despite we anticipate slight further cooling of the business activity and the labor market, there are no significant signs of a severe downturn. Moreover, the overall debt burden on companies and consumers remains at favorable levels, suggesting that absent external shocks, a soft landing is plausible. Based on historical patterns, current evaluations, and EPS expectations, we anticipate that the Healthcare, Consumer Durables, Communications, and Financials sectors may perform well over the next six months. Given strong sectoral trends (including huge AI prospects) and recent market correction, the IT sector may also show strong performance in the near future.
