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| Richard Drew/AP |
With signs of slowing job growth, investors are increasingly confident that the Federal Reserve will begin cutting interest rates at its September meeting. If history is any guide, those cuts could fuel a strong rally in stocks though not without risks.
Recent analysis by LPL Financial examined how the S&P 500 performed during the periods between the Fed's first rate cut in a cycle and the eventual resumption of rate hikes. The results suggest that rate reductions tend to give stocks a meaningful boost but not always.
Across nine rate-cutting cycles since 1974, the S&P 500 delivered average returns of 30.3%, with a median return of 13.3%. Stocks posted gains in six of the nine cycles, suggesting a generally favorable backdrop for equities once the Fed begins easing.
“Using history and prior Fed cutting cycles as a guide, some upside potential may remain for the second half of 2025,” said Jeff Buchbinder, LPL’s chief equity strategist, in a report published August 5. “But of course, past performance does not guarantee future results and a new tariff regime not seen since the 1930s could slow earnings growth and fuel volatility.”
Some of the most impressive stock market runs during rate-cutting cycles include the 161% surge from 1995 to 1999 during the dot-com boom, a 62.8% gain from 1984 to 1993, and a 38.2% rally from 2019 to 2021.
History Shows Rate Cuts Often Lift Stocks But Not Always
While the historical data offers reasons for optimism, it's not a guarantee. Rate cuts can sometimes coincide with or follow broader economic downturns and in those instances, stocks haven't fared as well.
During the 2007–2009 financial crisis, the S&P 500 dropped 23.5% even as the Fed slashed rates. Similarly, between 2001 and 2004, the index fell 9.6%, despite a multi-year easing cycle.
That’s why context matters.
This time around, Buchbinder warns that while rate cuts could support markets, several headwinds including overextended investor sentiment and ongoing economic uncertainty suggest caution is warranted. The market has already climbed 12% since the Fed’s first rate cut last September, raising questions about how much further gains can go in the short term.
“The delayed effects of trade policy are likely to weigh on the economy in the second half, leading to weaker labor market demand,” Buchbinder wrote. “Recent market complacency toward trade policy and an economic narrative dependent upon strong economic data has caught our attention in recent weeks as a potential point of weakness.”
Will the Fed Actually Cut Rates Again This Year?
While markets are currently pricing in a near-certainty of a September rate cut FedWatch data shows 93.2% odds not all economists agree.
Analysts at Morgan Stanley and Bank of America believe the Fed may hold rates steady for the rest of 2025, especially if inflation data remains stubborn or economic growth picks up unexpectedly. That divergence between market expectations and economist forecasts adds another layer of uncertainty to the outlook.
Navigating What Comes Next: Stay Invested, But Cautious
In this environment, LPL’s strategy team is advising investors to be cautious in the near term. Buchbinder recommends sticking to portfolio benchmarks and resisting the urge to chase additional equity exposure at least for now.
“Bottom line, investors may be well served by bracing for occasional bouts of volatility given how much optimism is currently reflected in equity prices,” he said.
LPL’s short-term asset allocation committee favors growth stocks, large caps, and sectors like financials and communication services. But they’re not advising investors to overweight equities just yet.
“We continue to monitor tariff negotiations, economic data, earnings, the bond market, and various technical indicators,” Buchbinder added, “to identify a potentially more attractive entry point to add equities on weakness.”
