As advisors anticipate the impact of the new Fed rate-cut cycle on client portfolios, many will probably rely on the conventional wisdom that cyclicals are likely to benefit the most.
While a lot of historical data suggests this impact, focusing on it too much may lead to missing opportunities, as market history points to less obvious parts of the market that may fare better.
Unlike most first Fed cuts, the 50 basis-point cut the Fed announced in September didn’t come in a sluggish or recessionary economic environment. Rather, it comes amid a particularly resilient economy that, while slowing somewhat, is still growing apace.
Hootie And The Blowfish
According to Forbes, the last time the Fed cut rates in a growing economy was in 1995, a year when the S&P 500 was net positive and tech stocks were mustering before their rapid ascent in the late ’90s.
The rate-cutting cycle that began in July of ’95 came as more affordable personal computers proliferated in households and the band Hootie & the Blowfish was a pop phenomenon.
Contrary to what many advisors believe today, the 1995 cut cycle didn’t resuscitate a dormant trade in cyclicals. While financials did all right after this first cut, most cyclicals declined, while some defensives ascended.
Over the six months after the first cut in July ’95, relative to the S&P 500, consumer staples outperformed by 4.9%. Healthcare did much better, outperforming by 14.8%.
Some of these gains may have come from siphoned-off tech investment. Despite strong growth in the first half of ’95, tech hit a performance top around the time of the Fed’s first cut and then promptly headed downward, remaining contained for about six months.
But, of course, by the time Hootie & the Blowfish lead singer Darius Rucker switched to country music in 2008, tech had been leading the market with meteoric growth for more than a decade.
1995 Revisited?
Outcomes from the 1995 cut cycle may hold clues to sector performance during and after this new, belated round of cuts.
Currently, as in 1995, the beginning of this cut cycle roughly coincides with a pause in the upward ascent of the Nasdaq 100, which underperformed the S&P 500 between July and late September. That, along with improved performance by the equal-weighted S&P 500, suggests overall market performance broadening from tech, reminiscent of what occurred early in the 1995 cut cycle.
Also, this new cut cycle and that of 1995 share similarities in their macro-economic environments. For example, as it is today, the dollar was weak in 1995; it gained strength during that cut cycle.
With anticipation of rate cuts in recent months, the inverted yield curve that nettled many advisors is no longer inverted, now reflecting a more “normal” rate spread. The yield curve did the same thing approaching the first cut in ’95.
Yet the macro-economic environment of the mid-90s and that of today, of course, have differences. And, as the markets of 1995 and 2024 are different creatures, with different investor sentiments, anyone seeking historical indications of sector outcomes for the next year or two should probably look at several cut cycles.
Undeniably, some cyclicals have done quite well amid cuts—notably, materials, which has outperformed during the last three cycles.
Increasingly Healthy
But the sector that emerges as perhaps the most consistent cut-cycle outperformer is healthcare. After outperforming relative to the S&P 500 in 1995, healthcare did so again in two-year periods after the first Fed cuts in the cycles of 2001, 2007 and 2019.
Though healthcare is a classic defensive sector, it has recently acquired offensive characteristics: a secular growth story, earnings growth projected to accelerate and margins projected to expand.
After languishing with low energy in recent years, healthcare has shown vitality in 2024, posting solid performance. At the outset of this new Fed cut cycle in late September, the SPDR healthcare ETF XLV was up about 19% for the preceding 12 months.
Though this sector is characteristically impervious to demand declines from rising unemployment—insured people will always seek care regardless of their financial situation—it can be a political punching bag regarding consumer costs, especially drug prices. Yet, as of early October, the sector had avoided excessive beratement at the hands of presidential election campaigns (though this could change before the election).
Charging Up
Another defensive sector that may be poised to perform in this new cut cycle is utilities, which has recently received more attention from investors’ growing awareness of the huge power demands from artificial intelligence.
Yet before “AI” was on everyone’s lips, data centers were already sucking up increasing amounts of power, along a myriad of rechargeable battery-operated products: electric cars, robotic vacuum cleaners, lawn motors, cell phones and all manner of other wireless devices. SPDR utilities ETF XLU was up more than 30% for the 12 months ended in late September.
Though the likely overall market impacts of this cut cycle are probably already baked into equity prices to a large extent, the coming cuts aren’t likely to hurt many stocks. After all, the costs of issuing bonds will decline with prevailing interest rates as the Fed continues slicing—probably in 25 basis-point increments.
With lower costs from issuing bonds, corporations will have more unencumbered cash to invest in their enterprises and pay off existing bonds, brightening balance sheets.
Future increments of 25 bps would be a methodical pace consistent with the months of methodical Fed talk that preceded the first cut.
Though the market has historically favored such small cuts, it has nevertheless welcomed the Fed’s kicking off this cycle with 50 bps, perhaps because cuts were so long in coming.
Barring negative impacts from unexpected exogenous events, the market’s welcome wagon for the new cut cycle will probably continue rolling through 2025 and into 2026, with sector outcomes less likely to surprise advisors who have taken a close look at market history.
Dave Sheaff Gilreath, CFP, is a founder and chief investment officer of Sheaff Brock Investment Advisors, a firm serving individual investors; and Innovative Portfolios, an institutional money management firm. Based in Indianapolis, the firms were managing assets of about $1.4 billion as of June 30.