Fed factor: Rate cut theory suggests higher equity valuations, but history tells a different story
equity valuations from lower interest rates.
Following the 2001 rate cuts, the Nifty fell by 35% over a one-year period. In the 2007-08 cycle, it initially gained 30% but later plunged by 60%. After the 2019 rate cuts, Nifty returns were flat, ranging between 0% and 5%, according to a note by Nuvama Institutional Equities.
«Fed rate cuts are generally in response to a growth slowdown and in most cases, the US economy ends up in a recession. It thus significantly lags the earnings cycle. Equity valuations respond not just to rates, but also to earnings outlook. And generally, rate cuts follow a period of strong growth and, consequently, elevated valuations (even at high/rising rates). Thus, delayed rate cuts offer little solace. Furthermore, rate cuts take time to trickle down into the economy and lift earnings. Hence, the relationship between rate cuts and market movements is rather nuanced,» the Nuvama's note said.
It’s only when rate cuts are deep and valuations cheap that they have a healing touch, the note further stated.
In contrast, the performance of Wall Street's S&P 500 index shows double-digit negative returns one year after the rate cuts of 2001 and 2007-08. According to Dow Jones Market Data shared by HDFC Securities with ETMarkets, the index fell by 10% and 21.69%, respectively. However, in 2019, following three rate cuts by the Fed, the S&P 500 rose by 9.8%.
Stock Trading
Market 101: An Insight into Trendlines and Momentum
By — Rohit Srivastava, Founder
Stock Trading
Markets 102: Mastering Sentiment
