After a long pause since the final rate hike this cycle in July 2023, the Federal Reserve initiated its easing cycle with a first-rate cut in September 2024. The only other time in recent history with the Fed leaving rates at the top for an extended period of time was the 15 months spanning June 2006 to September 2007, with the consequences all investors remember. Historically, central banks ease interest rate policies as the economy slows in order to stimulate demand and avoid a recession. When recession is avoided following an easing cycle, economists term this outcome a “soft landing”. While lower rates are stimulative for stocks, rate-cut cycles can be perilous for equity investors if aggregate demand continues to slow and the economy tips into recession.
This article studies the past Fed rate-cutting cycles and looks for parallels that could offer insights for tactical equity investors.
Seven rate-cutting cycles from 1984 are juxtaposed with the US equity market as represented by the S&P 500. We specifically look at equity market performance from the third rate cut in the cycle. On December 18, 2024, the Fed announced its third rate cut in the current easing cycle. The chart below highlights the third Fed rate cuts in our seven cases, mapped to the S&P 500 price index. 
In four cases (illustrated by the heavier vertical lines), the easing cycle finished with an official recession. As markets are forward-looking, typically the early part of a rate-cutting cycle is welcomed by equity markets, as lower rates are stimulative. But at some point in the rate-cutting cycle, markets begin to anticipate that lower rates will not avert the economic slowdown caused by the previous restrictive policy.
In the table below, we list the seven cases, noting the number of cuts in the cycle. Longer cutting cycles invariably correspond to a recessionary outcome. The next column situates the 3rd rate cut, in months, within the full cycle. For example, in the June 1989 to September 1992 easing cycle, the 3rd rate cut was fronted loaded, coming very early (with 92% of the time in the cycle remaining). Rapid rate cuts that are front-loaded in a cycle, consistent with a Federal Reserve concerned about the economic outlook, often portend a recessionary outcome. The second part of the table measures the S&P 500 price change following the 3rd rate cut. 
The first observation is that equity price performance has been negative each time a recession has ensued, denoted by the four cases with the lines in bold. The maximum drawdowns following July 1989, March 2001, December 2007, and October 2019 3rd rate cuts were -12.8%, -30.7%, -53.0% and -21.8%, respectively. Also, the duration the Fed leaves rates at the peak level following the final rate hike (for example in 2000 and in 2006/07) has been correlated with more severe recessions. In 2000 rates were left at the peak level of 6.5% for 8 months. In 2006/07 rates were left at the peak level of 5.25% for 14 months. Most recently in 2023/24, the Fed Funds rate was held at 5.5% for 14 months. Finally, we see that rate-cutting cycles have not always upset equity markets, as seen in the 1984, 1996, and 1998 cases.
So which case is the current rate-cutting cycle more likely tracking -- a recession with an almost inevitable S&P 500 drawdown or a soft landing with ongoing robust equity performance? To get an idea of the topography that prevailed in each case, we look first at a few valuation metrics that prevailed at the time of the 3rd rate cut. Then in a second analysis, we consider the message from the Treasury yield curve leading up to the Fed easing cycle.
The table below considers several widely followed valuation metrics for stocks.
What stands out immediately is that the three non-recessionary rate cut cycles showed much more reasonable equity valuations, in general. The exception was the 1998 case, which was nonetheless a prelude to the Tech Bubble. More interesting is comparing the current valuation metrics to the other historical cases. As of December 2024, the S&P 500 price-to-sales stood at 3.01x, well above the next two cases of 2.13x in October 2019 and 1.85x in November 1998. On the price-to-earnings, at 27.87x trailing earnings, the current S&P 500 valuation is at the most expensive point at any 3rd rate cut, save 1998. As for price-to-book, the current 5.21x is the richest of any prior cycle – by far. Finally, the Buffet Indicator, which takes the broad market Wilshire 5000 total market capitalization as a ratio to the size of the economy as represented by GDP, again shows that today the market is the most overvalued relative to any prior 3rd rate cut point.
A final point of comparison is the Treasury yield curve. Inverted yield curves have had an excellent track record of predicting recessions. Currently, the long inversion of the 10-2 yield curve has yet to produce a recession. In almost every prior easing cycle, the 10-2 yield curve has inverted or nearly inverted and during the re-steepening phase equity markets have seen significant draw-downs.
The behaviour of the yield curve preceding the 2024 Fed easing cycle most resembles 1989 and 2001 which is a deep, prolonged inversion of the 10/2 curve.
Conclusion
Drawing historical comparisons is not an exact science. In each rate-cutting cycle, the Fed was faced with different inflation and growth trade-offs. We share some takeaways that may guide investors going forward.
First, the longer the rate-cutting cycle continues, the more likely an unfavourable outcome for equity markets. Curiously, markets have reacted negatively to any news that would suggest that the Fed would need to cut rates fewer times. History suggests that less Fed rate cuts would be the best outcome for stocks. The longer the Fed cuts, the more likely we will be experiencing slowing aggregate demand in the economy that requires more Fed action.
The second takeaway is valuation. Excluding the 1998 pre-Tech Bubble case, soft-landing cases have always occurred when equity valuations have not been excessive. The stock market itself is a leading economic indicator, and when stocks are expensive and have a long way to fall, this creates a negative wealth effect for households.
The final takeaway is that cutting cycles have tended to be preceded by yield curve inversions. In each case of inversion (run-ups to 1989, 2001, and 2007), equities have dropped significantly during the re-steepening phase.
To conclude, in more than half the rate-cutting cycles since 1984, equities have experienced a significant drawdown. In the cycles where stock prices remained firm, equity valuations were much less stretched than the averages of the four metrics we presented above. Moreover, the degree of 10-2 Treasury yield curve inversion has been a determinant of the magnitude of equity draw-down during the Fed easing cycle. Again, the absence of yield curve inversion prior to the Fed cutting cycle has been consistent with ongoing robustness in stock prices.
Based on the comparisons to prior cycles, it appears the current Fed cycle is most consistent with 1998, 2001, 2007 and 2019 based on valuations and most similar to 1989, 2001, and 2007 yield curve behaviour. As a result, we’d put the odds of a significant equity down-down and/or recession at greater than 50/50 during this current Fed easing cycle. These odds would rise if the Fed easing cycle goes beyond 4 to 6 rate cuts.
Owen Willilams, DBA, CFA, is a Professor of Finance at the EM Lyon School of Business