Schroders notes that, based on the expectation that the US economy will not enter a recession and that the Fed will likely cut rates in September 2024, value, growth and quality stocks are likely to outperform the market. At the same time, defensive sectors may also perform well in a rate cut environment. Defensive sectors tend to outperform cyclical sectors after the Fed’s first rate cut. This is particularly true during economic recessions, possibly because investors seek to invest in sectors that are most likely to withstand a weak economy and benefit from more aggressive rate cuts. From a historical perspective, value and tech stocks tend to outperform in the US when inflation is near the Fed’s target of 2%.
By contrast, most cyclical sectors tend to underperform in the first three months after the first rate cut, especially if the rate cut is during an economic recession. However, cyclical sectors tend to provide strong returns after the first year of a monetary easing cycle. Initially, cyclical stocks are sold off due to weak economic growth and easing inflation pressure, but these stocks become more attractive as their valuations become cheaper and investors expect rate cuts to boost economic activity and corporate earnings. However, financial and discretionary sectors are exceptions, even in the first few months after the first rate cut.
It is worth noting that tech stocks tend to underperform in the first few months after a rate cut. In a rate cut cycle, quality and growth stocks tend to outperform, but by a smaller margin than cyclical stocks. Cyclical sectors such as tech tend to perform better in the stock market during a bull market, but also suffer more in a bear market. Growth, quality and value stocks tend to underperform during a monetary easing cycle when the Fed is cutting rates during an economic recession. This may be because investors tend to invest in more defensive sectors in financial markets, such as low volatility stocks.