While many have been arguing for the Federal Reserve to continue cutting its key interest rate to provide a boost on Wall Street, UBS argues that rate cuts don’t provide the same stock market boost investors have seen in the past.
The Fed cut its benchmark interest rate twice in the last three months, and the S&P 500 actually dipped slightly since the first cut in July, the first rate cut in more than a decade. UBS said it doesn’t see a correlation anymore between the S&P 500’s price-earnings ratio and the Fed rate policy because the early 2000s were dominated by low rates.
“Fed rate cuts are not likely to fuel equities higher as they did in the 1990s,” UBS equity strategist Francois Trahan wrote in a note this week. “The Fed-easing rallies of the 1990s were made possible by a strong inverse correlation between interest rates and P/Es. This relationship no longer exists today.”
Investors have been enduring a volatile market as the third quarter drew to a close Monday. The S&P 500 saw a slight gain overall as the market whipsawed throughout the quarter on breaking news regarding the ongoing trade war between the U.S. and China. August also saw the first contraction for U.S. manufacturing, according to data from the Institute for Supply Management, but Trahan says investors haven’t been as worried.
“Investor sentiment has been resilient in the face of the ISM crossing below 50 in August. We believe this resilience in sentiment is explained by the widespread belief that Fed rate cuts will help support S&P 500 P/Es as they did in the 1990s,” he said.
That sentiment could change, though, as new data released Tuesday showed the Purchasing Managers’ Index plummeting to 47.8% in September, its worst reading since June 2009. Anything under 50% is considered a contraction, of which President Donald Trump noted on Twitter, blaming the Fed.
As I predicted, Jay Powell and the Federal Reserve have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected. Fed Rate too high. They are their own worst enemies, they don’t have a clue. Pathetic!
— Donald J. Trump (@realDonaldTrump) October 1, 2019
Trahan also warned that heightened political uncertainty may put a damper on any hopes of a rate cut rally in the markets.
“Uncertainty at the White House continues to increase perception of risks,” Trahan said. “Add to the mix an official impeachment inquiry into President Trump and this will likely exacerbate the headline volatility we’ve seen in equities.”
The Fed is set to meet again on Oct. 30, and the CME FedWatch tool shows a 58% chance of another 25 basis points cut to a range of 1.5%-1.75%.
