(Written by Bert Dohmen, contains excerpts from our latest July 2025 Wellington Letter)
The current hype is that the Fed will cut rates soon, and that even if the markets weaken briefly, the rate cuts would boost stocks. Beware of that fairy tales!
There is an old saying amongst traders: “What everyone knows is not worth knowing.” In other words, what’s known is already in the markets.
Here is the chart from MacroTrends of the Fed Funds rate (orange line, right scale), which is directly set by the Fed, versus the S& P 500 (blue line, left scale) going back to the 1999.
It clearly shows that the start of the rate decline, although it has only happened 4 times over the past 25 years, is NOT immediately bullish for stocks. Many times it takes 1-2 years before the market turns up. The years 2002, 2009, and 2020 show such lags.
In March 2020, the market basically crashed (COVID pandemic) although the Fed started cutting rates 7 months earlier, from August-October 2019.
The table below of rate cuts and market performance thereafter between 1989 and 2007 makes it even clearer. Note the big market declines while the Fed continued to cuts rates in 2001 and 2007. It could happen again.
Of course, it’s important to point out that the cuts starting 1998 coincided with the middle phase of the “dotcom bubble” (between 1995-2000), which was a great new technology. Thus, it was the technology that created the strong market, not the cuts.
Currently we are in the early phase of a tremendous new technology, AI, that we believe is even more revolutionary than the internet. That could support economic activity for certain sectors, especially those who can reduce their work force significantly. But rising unemployment could be bad for the economy as a whole. It is a double-edged sword, depending on the industry sector.
The chart below of the S&P 500 from 2000 to 2003 shows that even with the rate cut in January 2001, the market continued declining.
The market decline from the year 2000 peak to the September 2021 bottom was 39%. The Fed Funds rate plunged from 6.5% to 2% in that first year (currently the Fed Funds rate is between 4.25%-4.50%.) But the market decline continued another whole year into the October 2022 bottom.
Wouldn’t that be a shocker if the Fed cut rates at the end of July, but the stock market would decline another year?! There is a good chance that will happen, except for a brief knee-jerk reaction.
WOULD RATE CUTS BE INFLATIONARY?:
The President of the US has been urging the Fed to reduce interest rates. Analysts say that would be inflationary.
However, the Fed would only cut rates if economic numbers are poor, as a response. The bad economy is more important for stock investors than a cut in interest rates.
Furthermore, a lower “cost of money” (interest rate) would actually reduce price increases because it would lower the cost of doing business.
That is why hiking rates in an effort to fight inflation does not work. But they don’t teach that in economic class. I know, I took advanced economics, in addition to my major in Chemistry. I debated my professor on the subject. I got an A- in my advanced econ class. I felt that the minus was for disagreeing with him.
Always remember, the CPI and other inflation numbers are manipulated by changing the components and the calculations.
As in the late 1970’s, the distortions of economic numbers due to the pro-inflation policies give investors and analysts a false picture of prosperity. But it brought some major opportunities to investors at that time.
Example: there was a major boom in commodities, gold and silver, copper, and certain stock sectors for a few years in the late 1970’s. Our subscribers benefitted from that boom.
We even had a commodity newsletter for a few years. And then we sold all the commodities and went short in 1980 when Paul Volker correctly fought record high inflation with truly “tight money, ” i.e. reducing the availability of credit.
You see, knowing when to sell is just as important as when to buy.
We discuss the significance of the Fed’s next move (potentially on July 30) and how it will be key for determining market’s next trend in more detail in our July issue of the award-winning Wellington Letter.
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Bert Dohmen, Founder
Dohmen Capital Research
Editor, The Wellington Letter