In case you missed the news this week; the Federal Reserve decided to cut rates on September 18^th, 2024, by 0.50%  As usual, the news was hard to miss thanks to the financial media who love discussing what the Fed may, may not, did or did not do.

Watching the Fed is nothing new. During Alan Greenspan's time as Fed Chairman, it was rumored that traders on Wall Street would watch for his arrival that morning and analyze the size of his briefcase.

The theory would go, if Greenspan's briefcase was larger than usual, he was carrying ample evidence to persuade other members of the FOMC to raise rates. Unfortunately, this theory left many traders looking for a new career.

INSIDE THE BRIEFCASE: THE ART OF PREDICTING THE FEDERAL RESERVE (stlouisfed.org)

The Market Already Knows...

Here is the beautiful thing about financial markets, they do a remarkable job at gathering everyone’s views and adjusting prices. Market’s do not operate based off certainties, instead future outcomes are determined based on probabilities. See for yourself! You can check out a live look at future probabilities on Federal Reserve decisions here: CME FedWatch - CME Group

It even comes equipped with a real-time clock so you can countdown the moments until the Fed’s next decision:

The team at Dimensional took these probabilities and aggregated them into a graph to provide investors with a visual of what markets are saying:

First, we can see that the dots on the top chart are slowly declining as we move further out indicating that the market is anticipating lower rates in 2025 and beyond.  Second, the bottom chart is shaded to indicate the likelihood of where the Federal Reserve eventually lands with their policy. We observe that as we move to the right on the graph (further out into the future), the shading decreases and more boxes within each column are now colored indicating a potential landing spot.  This illustrates uncertainty and is a driving force behind the returns investors earn over time.

Saying rates will decrease holds no value for investors; rather, for one to profit from rate movements they need to consistently outguess what the market has already priced in.  This is to say that one can accurately predict surprising events, and surprises are unpredictable otherwise they cease to surprise us.  

Will This Impact My Portfolio?

The research team at Dimensional looked at the impact Federal Reserve rate decisions have on corresponding stock returns.  Let’s say there was some sort of reliable relationship between interest rate decisions and future stock returns, we would see charts looking something like below:

Here is what reality looks like:

The real-world results shown above illustrate no reliable pattern between the Federal Reserve’s decision and the stock market’s subsequent performance.  This result is further proof that markets are doing a good job incorporating all investors’ expectations into current prices. If it were any other way, we would find the relationships shown prior where one variable predicts the other over time.

What About Small Cap Stocks?

One theory is that smaller companies tend to have a higher cost of debt on their balance sheets; hence, they have more sensitivity to interest rates. Afterall, smaller companies have less pricing power in their industries and their earnings may be more volatile over time, so lenders demand a higher rate on their debt.  

Dimensional looked at the data going back to 1962 and found no reliable pattern between rate changes and small cap stock returns. Again, the dots on the chart plot all over the place in no consistent pattern:

Conclusion

We should recognize that the financial media and experts make a living through your viewership. The Federal Reserve provides them with copious amounts of marketing material to pitch to viewers in hopes of gaining a "leg up" on the markets. Would you want the Federal Government to dictate your investment portfolio? Investors would be better served by determining the proper allocation between assets such as stocks and bonds within their portfolio based on their own financial needs and then remain committed to holding that allocation regardless of what action any government body takes.