Will Stocks Rally Through Year Two of the Fed Cutting Cycle?

Not too shabby. Most of these numbers are above zero for both the first year and second year of historical rate-cutting cycles over the past 50 years. The average gain during year one was 9.6%, and the median was 16.4%. Stocks fared better during year one of the current cycle with a more than 17% return since the half-point cut on September 18 of last year.

Turning to year two, the average and median gains were excellent at 16.4% and 14.4%, respectively. We would happily accept these returns over the next twelve months, but they may be overly optimistic given lofty valuations.

Economic Environment is Key

These are excellent historical returns, but as the accompanying chart illustrates, stocks fell during some of these cycles. Stocks fell during the 1980–81 cycles (double-dip recession), the 2001 cycle (recession), and the 2007 cutting cycle (recession). In other words, if stocks are going to rise over the next 12 months, it will likely require economic growth to continue. We think it will, supported by stable interest rates, cooling inflation, fiscal stimulus, continued robust artificial intelligence investment, productivity gains, and more rate cuts.

But this macroeconomic outlook is far from assured. Deficit spending may put upward pressure on long-term interest rates. A stalled job market may spark recession fears. Legal challenges to tariffs bring uncertainty. The geopolitical landscape is fraught with risks. And with stock valuations elevated, it’s possible that stocks produce lackluster returns even in a favorable economic environment.

Conclusion

The first year of this rate-cutting cycle has been excellent for stocks, and history offers a reason for optimism as the cycle continues. Year two of rate-cutting cycles has historically delivered solid gains for stocks — provided the economy avoids recession. Markets like rate cuts that are a luxury, not an emergency. With the Fed likely to signal more easing ahead, and near-term recession risk seemingly low, the backdrop for stocks remains constructive.

Jeff Buchbinder, CFA, provides the top-down view of the stock market for LPL Financial Research. He has over 25 years of experience in equities.

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