Monetary Policy Changes Since WW2

Given the Fed’s rate cut last month, I thought it would be interesting to see what has historically happened to the stock market when the Fed changed its Monetary Policy.  The table below summarizes what types of stocks performed best and worst during those policy eras:

Era	Outperformed	Underperformed	Economic Reasoning
1950s-1960s (Post-WWII)	Small-Cap Growth	Large-Cap Value	Easing cycles post-war supported growth stocks as liquidity improved, while value lagged during expansion.
Late 1960s Tightening	Large-Cap Value	Small-Cap Growth	Tightening cycle led to rising rates and inflation concerns, benefiting stable cash flow value stocks.
1980s (Volcker Era)	Large-Cap Value	Small-Cap Growth	Tight rate hikes to combat inflation favored value stocks; high borrowing costs hurt growth companies.
Mid to Late 1980s Easing	Small-Cap Growth	Large-Cap Value	Easing spurred economic expansion and risk appetite, benefiting growth stocks amid renewed liquidity.
2000 Dot-Com Bubble	Large-Cap Value	Small-Cap Growth	After the bubble burst, tightening led to outperformance of stable sectors, while growth suffered.
2001 Easing Cycle	Small-Cap Growth	Large-Cap Value	Recovery from the tech bubble and easier borrowing conditions drove strong small-cap growth gains.
2008 Financial Crisis Easing	Small-Cap Growth	Large-Cap Value	Aggressive easing led to increased risk-taking, with growth stocks rebounding in a low-rate environment.
2015-2018 Tightening	Large-Cap Value	Small-Cap Growth	Rate hikes led investors toward stable value stocks, and higher discount rates hurt small-cap growth.
2020 COVID-19 Easing	Small-Cap Growth	Large-Cap Value	Massive easing led to a rally in high-growth sectors; liquidity and stay-at-home trends fueled tech stocks.
2022-2023 Tightening	Large-Cap Value	Small-Cap Growth	Tightening to combat inflation led to the outperformance of energy and defensive sectors over growth stocks.

From this table, we see the following:

1. Relationship Between Interest Rates and Stock Categories:
   • Historically, changes in Federal Reserve policy—specifically shifts between easing and tightening cycles—have consistently influenced the performance of various stock categories.
   • When interest rates fall (easing), growth stocks, especially small-cap growth, tend to thrive due to improved access to capital and lower discount rates on future earnings.
   • During periods of tightening, when rates rise, value stocks tend to outperform because of their stable cash flows and reduced reliance on external financing.
2. Growth vs. Value Dynamics:
   • Growth Stocks: These stocks, particularly in the small-cap space, are more sensitive to changes in monetary policy due to their dependence on future earnings growth. In a low-rate environment, growth stocks benefit from the lower cost of capital and increased investor risk appetite. 
   • Value Stocks: Large-cap value stocks tend to do better during tightening cycles because they offer stability, dividends, and less exposure to rising borrowing costs. This makes them attractive when economic uncertainty or higher rates are present. 
   • Lower interest rates reduce discount rates in the valuation of companies, valuing the future earnings of growth stocks higher than the current earnings of value stocks.
   • Higher interest rates increase discount rates in the valuation of companies, valuing the current earnings of value stocks higher than the future earnings of growth stocks.
3. Small-Cap vs. Large-Cap Performance:
   • Small-Cap Growth: During easing cycles—such as post-2008 and post-COVID—small-cap growth stocks significantly outperformed, often driven by increased economic optimism and abundant liquidity.
   • Large-Cap Value: In tightening periods like the 1980s (Volcker Era) or 2022-2023, large-cap value stocks generally performed better, benefiting from stable cash flows and investor rotation into safer assets amid higher rates.
4. Economic Context Matters:
   • Understanding the broader economic context behind each Fed cycle is crucial. For example, the 2000 Dot-Com Bubble saw large-cap value outperform as investors moved away from speculative growth stocks, while the 2008 Financial Crisis and 2020 COVID-19 Easing saw aggressive monetary easing that drove a rally in growth sectors.
   • Each easing or tightening cycle comes with unique economic conditions, whether it be inflation concerns, economic recovery, or technological shifts, meaning that no monetary cycle is exactly the same.
   • It’s the macroeconomic factors that help explain the performance dynamics across industries within the same sector and help to guide investment strategy decisions.

4. Investment Strategy Implications:
   • Investors need to keep track of where the Fed is in its rate cycle. During easing phases, allocating more to growth sectors, especially small-cap growth, could lead to higher returns. Conversely, a shift toward value stocks, particularly large-cap value, might provide better risk-adjusted returns during tightening phases.
   • Diversification across growth and value stocks, as well as across different market caps, can help mitigate many investment risks, but overweighting certain types of stocks compared to others is the key to outperforming the broader market.
5. Risk and Opportunity:
   • Small-cap stocks, particularly growth, tend to be more volatile compared to large-caps. In easing cycles, they present substantial opportunities but carry higher risks. Conversely, large-cap value stocks offer relative safety in tightening cycles, particularly in sectors like utilities, consumer staples, and energy.
   • However, certain sub-industries within larger sectors sometimes have macro catalysts that surpass the impact of monetary tightening.  A good example is utilities with broad nuclear exposure are currently outperforming the broader market despite the sector being a defensive sector.  This is due to the macroeconomic impact of both the move to clean energy and the need for increased energy production near large data centers that process AI and cloud services.
6. Sectoral Rotation:
   • Investors often rotate between sectors based on changes in monetary policy. For instance, during the 2022-2023 Tightening cycle, energy and defensive sectors outperformed as they provided income and stability, which were highly valued amid rising rates and inflation concerns.

The Current Easing Cycle

Since we are now a month into the monetary easing cycle that started in September, let’s review what has happened with the stock and bond market:

“Magnificent 7” vs. Rest of the S&P 500:

• “Magnificent 7” Stocks (Apple, Microsoft, Amazon, Alphabet, Meta, Tesla, Nvidia):
  • Performance Since Rate Cut: The “Magnificent 7” have outperformed the broader market, with gains averaging around 8-10% since the rate cut. These stocks have benefited most from the perception of improved liquidity and reduced discount rates, which is particularly favorable for high-growth tech giants.
  • Key Drivers: Lower interest rates are particularly supportive for companies with high valuations driven by future earnings growth. The Magnificent 7 stocks have rallied as investors anticipated that these companies will benefit more from improved capital access and reduced borrowing costs, given their scale and growth prospects.
• Rest of the S&P 500:
  • Performance Since Rate Cut: The remaining companies in the S&P 500 have seen more modest gains, averaging around 3-4%. Traditional sectors like energy, consumer staples, and healthcare have been less impacted by the rate cut, as the benefits of lower rates are more muted for established, lower-growth firms.
  • Key Drivers: Sectors like utilities and consumer staples have performed in line with the index, while financials have struggled due to lower interest rate spreads affecting profitability.

Small and Mid-Cap Stocks:

• Small-Cap Stocks (Russell 2000 Index):
  • Prior to Rate Cut: The Russell 2000 Index was trading at around 1,890.
  • Current Level (October 15th): Currently at approximately 1,940, representing an increase of around 2.6% since the rate cut.
  • Key Drivers: Small caps have lagged larger stocks, as concerns about economic resilience and credit conditions still weigh on smaller companies, which tend to have less diversified business models and rely more on borrowing.
• Mid-Cap Stocks (S&P 400 Mid-Cap Index):
  • Prior to Rate Cut: The S&P 400 Mid-Cap Index was at around 2,650.
  • Current Level (October 15th): Now trading at around 2,720, reflecting a gain of roughly 2.6% since the rate cut.
  • Key Drivers: Similar to small caps, mid-cap companies have seen less pronounced gains compared to the Magnificent 7, given their growth potential but increased exposure to borrowing costs and market liquidity risks.

Growth vs. Value Stocks:

• Growth Stocks (Russell 1000 Growth Index):
  • Performance Since Rate Cut: Growth stocks have surged 7-8% since the rate cut, as they are highly sensitive to changes in interest rates. Lower rates have improved the valuation outlook for these stocks, especially those whose value lies in future earnings growth, which are now being discounted at lower rates.
  • Key Drivers: Growth sectors like technology, communication services, and consumer discretionary have all performed strongly, benefiting from both improved macro conditions and specific company-level tailwinds.
• Value Stocks (Russell 1000 Value Index):
  • Performance Since Rate Cut: Value stocks have increased by approximately 2.5-3.0%. Value-oriented sectors such as financials and industrials have lagged, as the benefits of lower interest rates are less clear-cut for mature businesses with stable cash flows.
  • Key Drivers: Financials have been negatively impacted due to the flattening and steepening of parts of the yield curve, which narrows interest margins. On the other hand, sectors like energy have seen support from other factors, such as oil prices, which somewhat offset the relatively smaller impact of the rate cut.

Small-Cap Growth Stocks vs. Small-Cap Value Stocks:

• Small-Cap Growth Stocks (Russell 2000 Growth Index):
  • Performance Since Rate Cut: The Russell 2000 Growth Index has risen by approximately 3.5-4.0% since the rate cut. Growth-oriented small-cap companies, often from sectors like technology and healthcare, have seen some improvement as lower interest rates favor companies with strong growth potential.
  • Key Drivers: Although small-cap growth stocks have benefited from the general decline in rates, they have not experienced gains comparable to large-cap growth stocks. Factors like elevated market volatility and ongoing economic uncertainty have limited the magnitude of their rebound.
• Small-Cap Value Stocks (Russell 2000 Value Index):
  • Performance Since Rate Cut: The Russell 2000 Value Index has increased by approximately 1.5-2.0% since the rate cut. Value stocks have underperformed growth stocks, reflecting the limited impact of lower rates on sectors like financials, industrials, and energy.
  • Key Drivers: Small-cap value stocks have not seen the same degree of price appreciation, as the interest rate cut primarily benefits companies with high growth prospects and

future earnings expectations. Additionally, concerns about profitability in the face of potential economic challenges have also weighed on value stocks in the small-cap space.

Stock Market Sector Performance Since Rate Cut (Early September to October 15th):

1. Technology (XLK):

• Performance: +7.5%
• Key Drivers: Lower interest rates benefit growth stocks, particularly tech companies with high future earnings potential. Strong earnings from major tech companies have also driven gains.
• Example Stocks:
  • Apple (AAPL): +6.8%
  • Microsoft (MSFT): +7.3%
  • NVIDIA (NVDA): +9.0%

2. Communication Services (XLC):

• Performance: +6.8%
• Key Drivers: The sector has benefited from the rate cut, which reduces discount rates for companies with strong growth prospects. Key players like Alphabet and Meta have seen a significant boost.
• Example Stocks:
  • Alphabet (GOOGL): +7.1%
  • Meta Platforms (META): +8.0%
  • Netflix (NFLX): +6.5%

3. Consumer Discretionary (XLY):

• Performance: +6.0%
• Key Drivers: Lower borrowing costs are supportive of consumer spending, benefiting companies in this sector. Retailers, automakers, and e-commerce companies have outperformed.
• Example Stocks:
  • Amazon (AMZN): +7.0%
  • Tesla (TSLA): +5.8%
  • Nike (NKE): +5.3%

4. Real Estate (XLRE):

• Performance: +5.2%
• Key Drivers: The rate cut has helped reduce mortgage rates, benefiting real estate investment trusts (REITs) and property developers. The prospect of reduced borrowing costs has improved sentiment in the sector.
• Example Stocks:
  • Prologis (PLD): +4.8%
  • American Tower (AMT): +5.5%
  • Simon Property Group (SPG): +5.2%

5. Industrials (XLI):

• Performance: +4.1%
• Key Drivers: Industrials have seen moderate gains due to a more optimistic outlook for economic growth, which improves demand for industrial goods and services. However, ongoing concerns around global demand have limited gains.
• Example Stocks:
  • Honeywell (HON): +4.2%
  • Caterpillar (CAT): +3.9%
  • General Electric (GE): +4.5%

6. Health Care (XLV):

• Performance: +3.8%
• Key Drivers: The defensive nature of the health care sector has limited the magnitude of gains, as investors favored higher-growth sectors. However, stable earnings and continued demand for health care services have kept the sector positive.
• Example Stocks:
  • UnitedHealth Group (UNH): +3.5%
  • Johnson & Johnson (JNJ): +3.2%
  • Pfizer (PFE): +4.1%

7. Financials (XLF):

• Performance: +2.9%
• Key Drivers: The rate cut has pressured net interest margins for banks, leading to underperformance compared to other sectors. Lower rates generally reduce the profitability of lending operations, although some optimism for loan growth has provided support.
• Example Stocks:
  • JPMorgan Chase (JPM): +3.1%
  • Bank of America (BAC): +2.5%
  • Wells Fargo (WFC): +2.7%

8. Consumer Staples (XLP):

• Performance: +2.7%
• Key Drivers: Consumer staples have underperformed due to their defensive characteristics. With the rate cut prompting a “risk-on” environment, investors have rotated away from staples toward more growth-oriented sectors.
• Example Stocks:
  • Procter & Gamble (PG): +2.3%
  • Coca-Cola (KO): +2.9%
  • PepsiCo (PEP): +2.6%

9. Materials (XLB):

• Performance: +2.5%
• Key Drivers: Materials have seen limited gains as the economic outlook has been mixed. Lower rates are supportive, but concerns about global growth and demand for commodities have kept gains modest.
• Example Stocks:
  • Dow Inc. (DOW): +2.4%
  • Linde plc (LIN): +2.8%
  • Freeport-McMoRan (FCX): +2.3%

10. Utilities (XLU):

• Performance: +1.8%
• Key Drivers: Utilities, typically a defensive sector, have lagged behind as investors favored riskier assets. Lower interest rates are generally supportive of utilities, but the shift toward growth has reduced demand for these stocks.
• Example Stocks:
  • NextEra Energy (NEE): +1.5%
  • Duke Energy (DUK): +1.7%
  • Southern Company (SO): +2.1%

11. Energy (XLE):

• Performance: +1.5%
• Key Drivers: The energy sector has underperformed despite stable oil prices. Concerns around global demand and recession fears have weighed on the sector, although ongoing OPEC production cuts have offered some support.
• Example Stocks:
  • ExxonMobil (XOM): +1.3%
  • Chevron (CVX): +1.6%
  • ConocoPhillips (COP): +1.7%

12. Aerospace & Defense:

• Performance: +4.0%
• Key Drivers: Defense spending remains a supportive factor, particularly with elevated geopolitical tensions. However, the performance has been tempered by broader concerns around government budgets and overall spending priorities.
• Example Stocks:
  • Lockheed Martin (LMT): +3.8%
  • Northrop Grumman (NOC): +4.2%
  • Raytheon Technologies (RTX): +4.1%

13. Biotechnology:

• Performance: +6.5%
• Key Drivers: The lower interest rates have benefited biotech companies, especially those with promising drug pipelines. The reduction in the discount rate has improved valuations. Positive clinical trials and regulatory approvals of new drugs have also contributed to gains.
• Example Stocks:
  • Amgen (AMGN): +6.0%
  • Gilead Sciences (GILD): +6.7%
  • Regeneron Pharmaceuticals (REGN): +7.0%

14. Agriculture & Agribusiness:

• Performance: +2.0%
• Key Drivers: The agriculture sector has faced mixed headwinds, including volatile commodity prices and unpredictable global weather patterns. Lower rates have provided modest support but concerns around pricing and profitability have limited gains.
• Example Stocks:
  • Deere & Company (DE): +1.9%
  • Archer Daniels Midland (ADM): +2.2%
  • Corteva (CTVA): +2.0%

15. Precious Metals (Gold & Silver Mining):

• Performance: +3.5%
• Key Drivers: Gold and silver miners have seen modest gains, benefiting from a weaker U.S. dollar, which makes precious metals more attractive. The rate cut has helped lower the opportunity cost of holding gold, but lower inflation expectations have kept gains from being more significant.
• Example Stocks:
  • Barrick Gold (GOLD): +3.3%
  • Newmont Corporation (NEM): +3.6%
  • Wheaton Precious Metals (WPM): +3.5%

16. Nuclear Energy:

• Performance: +4.7%
• Key Drivers: Growing support for green energy initiatives and the ongoing push for clean, carbon-free power have buoyed nuclear energy stocks. Lower financing costs have also supported the build-out of new reactors, particularly in emerging markets.
• Example Stocks:
  • Cameco Corporation (CCJ): +4.5%
  • Brookfield Renewable Partners (BEP): +4.9%
  • NextEra Energy Partners (NEP): +4.8%

17. Semiconductors:

• Performance: +8.3%
• Key Drivers: The semiconductor industry has been one of the top-performing subgroups, benefiting from increased demand for chips, particularly in AI and electric vehicle (EV) applications. The rate cut has boosted growth prospects for these capital-intensive companies.
• Example Stocks:
  • Advanced Micro Devices (AMD): +9.0%
  • Taiwan Semiconductor (TSM): +8.5%
  • Intel Corporation (INTC): +7.5%

18. Renewable Energy & Solar:

• Performance: +5.8%
• Key Drivers: Renewables have seen gains as lower rates make capital-intensive solar and wind projects more economical. Continued support from government subsidies and initiatives promoting green energy have been positive tailwinds for the sector.
• Example Stocks:
  • First Solar (FSLR): +5.7%
  • Sunrun (RUN): +5.9%
  • Enphase Energy (ENPH): +6.0%

19. Oil & Gas Exploration and Production (E&P):

• Performance: +1.0%
• Key Drivers: The oil and gas E&P segment has underperformed compared to other growth sectors. Concerns about global energy demand, along with the balancing act between production cuts and global supply/demand dynamics, have kept gains minimal.
• Example Stocks:
  • EOG Resources (EOG): +0.9%
  • Pioneer Natural Resources (PXD): +1.2%
  • Devon Energy (DVN): +1.0%

20. Industrial Machinery & Equipment:

• Performance: +3.3%
• Key Drivers: Improved economic sentiment and hopes for increased capital expenditure have supported gains in the industrial machinery sector. Lower rates have reduced financing costs, but ongoing uncertainty in the global economy has held back more substantial growth.
• Example Stocks:
  • Caterpillar (CAT): +3.1%
  • Deere & Company (DE): +3.5%
  • Parker-Hannifin (PH): +3.4%

21. Pharmaceuticals:

• Performance: +3.0%
• Key Drivers: Pharmaceuticals have seen steady but modest gains, reflecting the defensive nature of the industry. While some specific companies have outperformed due to drug approvals or breakthroughs, the overall sector has lagged compared to higher-growth areas like Biotech.
• Example Stocks:
  • Merck & Co. (MRK): +3.1%
  • Bristol-Myers Squibb (BMY): +2.9%
  • AstraZeneca (AZN): +3.0%

22. Financial Technology (Fintech):

• Performance: +6.2%
• Key Drivers: Fintech companies have benefited from lower rates, which have encouraged investments in digital financial services. Optimism around financial innovation, digital payments, and crypto technologies has driven much of the gains since the rate cut.
• Example Stocks:
  • PayPal Holdings (PYPL): +6.0%
  • Block, Inc. (SQ): +6.5%
  • Robinhood Markets (HOOD): +6.2%

23. Retail – E-Commerce:

• Performance: +6.7%
• Key Drivers: E-commerce companies have outperformed traditional retail, benefiting from lower borrowing costs and strong consumer spending. Growth expectations and digital transformation trends have supported valuations.
• Example Stocks:
  • Amazon (AMZN): +7.0%
  • Shopify (SHOP): +6.8%
  • eBay (EBAY): +6.3%

24. Precious Metals Refining & Mining:

• Performance: +4.2%
• Key Drivers: A weaker dollar and relatively stable prices for precious metals like gold and silver have supported miners and refiners. Investors view metals as a hedge in the face of uncertainties in the global economic outlook.
• Example Stocks:
  • Franco-Nevada Corporation (FNV): +4.3%
  • Royal Gold (RGLD): +4.0%
  • Sibanye Stillwater (SBSW): +4.1%

25. Utilities – Renewable Focus:

• Performance: +3.9%
• Key Drivers: Utilities focusing on renewable energy have benefited from lower rates and a shift towards green energy initiatives. However, the sector’s overall defensive nature has limited its outperformance relative to higher-risk growth areas.
• Example Stocks:
  • NextEra Energy (NEE): +3.7%
  • Brookfield Renewable Corporation (BEPC): +4.1%
  • Algonquin Power & Utilities (AQN): +3.9%

26. Utilities – Nuclear Focus:

• Performance: +4.5%
• Key Drivers: Utilities focusing on nuclear energy have benefited from the growing demand for massive electricity generation, particularly from data centers supporting AI applications. The need for reliable, carbon-free power sources has provided a strong tailwind for this segment.
• Example Stocks:
  • Constellation Energy (CEG): +4.6%
  • Duke Energy (DUK): +4.3%
  • Entergy Corporation (ETR): +4.5%

Conclusion

The Federal Reserve’s recent rate cut has had a significant impact on the stock market, largely aligning with historical patterns observed during easing cycles. The “Magnificent 7” tech giants have outperformed the broader market, while small-cap and value stocks have seen more modest gains. This divergence highlights the ongoing trend of market concentration and the outsized influence of large tech companies on overall market performance.

As we move forward, investors should remain vigilant of several key factors:

1. The duration and extent of the current easing cycle: Further rate cuts could amplify the trends discussed here, potentially widening the performance gap between growth and value stocks.
2. Economic indicators: Inflation, employment data, and GDP growth in coming months or years will influence both Fed policy and market sentiment.
3. Sector rotation: As shown above in the detailed sector analysis, different industries react differently to monetary policy changes and Macroeconomic factors.
4. Global economic conditions: With interconnected markets, international economic health and geopolitical events (just a couple of the Macroeconomic factors) can significantly impact domestic market performance.
5. Technological advancements: The strong performance of tech-related sectors underscores the importance of staying informed about emerging technologies and their potential market impacts.  AI and its growing use in business will be a secular trend, much like cloud computing was in its infancy.

While historical patterns provide valuable insights, it’s crucial to remember that past performance does not guarantee future results. The unique economic landscape we find ourselves in, shaped by factors such as ongoing technological disruption, changing energy dynamics, and evolving global trade relationships, may lead to outcomes that deviate from historical norms.  As such, our active management style can capitalize upon market dynamics for our clients’ financial benefit.