The Fed Is Done, and That’s Good

05/28/2008 12:00 am EST

Focus: MARKETS

Sam Stovall

Chief Investment Strategist, CFRA Research

Sam Stovall, Standard & Poor's chief investment strategist, says that stocks usually do well in the months after the Fed finishes cutting rates-particularly some sectors.

Standard & Poor's believes the Federal Reserve has likely cut the fed funds rate for the last time for this rate-easing cycle at its most recent Federal Open Market Committee (FOMC) meeting.

We think the Fed will now sit back and watch three things.

First, they'll see if the prior rate cuts have begun to bolster the economy, as it typically takes rate cuts six to 12 months to work their way into the system.

Second, the Fed will watch if the tax-rebate program will begin to jump start a sluggish economy.

Finally, the Fed will wait and see if the rate reductions and rebate checks will lead to an acceleration of inflation indicators, which could force the Fed to begin raising rates sooner than the average of 13 months after the last cycles.

If the Federal Reserve has stopped cutting interest rates, should investors panic? Not according to history. In the 12 times since World War II that the Fed ended its rate-easing efforts, the succession of interest-rate reductions and the economic stimulation has made investors more bullish on both the economy and the markets.

In addition, looking at performances since 1980 (the earliest observation common to all indices), we see that while stocks in general have done well after the last rate cut, growth issues have beaten value stocks, and small caps have outpaced them all.

Encouraged by the market's performances after the last rate cut, and digging a little deeper to see how sectors performed after the last cut, we see that the strongest price performances came from the cyclical consumer discretionary, industrials, and information technology sectors in both the six- and 12-month periods [after the final rate cut], as they posted above-average price advances and frequencies of market outperformance.

The traditionally defensive sectors-consumer staples, health care, and utilities-which normally held up well during rough patches in the market's performance, were underperformers in both periods, possibly as a result of investors' continued interest in the more cyclical sectors.

Interestingly, energy and materials-today's sector leaders-historically maintained their leadership positions in the first six months after the Fed stopped cutting rates, but then slowed to become market performers during the 12-month period.

Remember, of course, that past performance is no guarantee of future results.

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