On August 1st, the July jobs report showed that unemployment ticked up to 4.1%. While this is still a very low reading by historical standards, it was a notable increase relative to market expectations. This unexpected softening in labor caused a dramatic sell-off in the stock market, as market participants began to fear the Fed waited too long to lower rates. In the days that followed, we got an inflation reading, which showed the Consumer Price Index (“CPI”) dropped to 2.9%. While this is still above the Fed’s long-term 2% target, it does give a signal that perhaps inflation is beginning to move lower. These economic data releases have shifted the risks from purely that of inflation to a more balanced condition.

The Federal Reserve, which has been in a pause mode after a rapid series of rate hikes in 2022 and early 2023, is now expected to begin cutting rates. Consensus estimates are currently for a 0.25% reduction. However, there is a very real possibility that a more aggressive 0.50% cut could be on the table.

At CAISSA Wealth Strategies, we believe that understanding the nuances of rate-cutting cycles is crucial for our clients. Historical data shows that the Federal Reserve’s approach to easing monetary policy can significantly impact market outcomes, and the distinction between slow and fast rate cuts is particularly noteworthy.

The Importance of Slow and Methodical Rate Cuts

History has shown that slow and methodical rate-cutting cycles—defined as those with fewer than five rate cuts per year—tend to be more beneficial for equities compared to fast cycles. During slow cycles, the Federal Reserve cuts rates in a measured manner, often in response to a controlled economic slowdown rather than a full-blown recession or financial crisis. This approach provides a more stable environment for investors, allowing for gradual adjustments in market expectations and reducing the likelihood of sharp market drawdowns.

On the other hand, fast rate-cutting cycles, where the Fed cuts rates more aggressively (five or more times a year), are typically associated with more severe economic downturns. These cycles often occur in response to recessions or financial crises, leading to greater volatility and larger drawdowns in equity markets.

Our analysis indicates that slow-cutting cycles have consistently been more rewarding for equities, particularly within the first year after the initial rate cut. This pattern aligns with the intuitive understanding that a more aggressive Fed often battles more severe economic conditions.

The pace of rate cuts also has important implications for sector performance. Slow-cutting cycles have historically favored cyclical sectors—such as Energy, Materials, Industrials, Consumer Discretionary, Financials, Technology, and Communication Services—over defensive sectors like Consumer Staples, Health Care, and Utilities. Cyclical sectors tend to benefit from the gradual easing of monetary policy, which supports economic growth and boosts demand for their products and services. In contrast, defensive sectors, which are often less sensitive to economic cycles, may underperform during slow-cutting cycles.

Looking Ahead: What It Means for CAISSA Clients

As we move into this next phase of the economic cycle, our team at CAISSA Wealth Strategies has proactively positioned portfolios to benefit from this future interest rate-cutting cycle. The potential for slow and methodical rate cuts presents an opportunity for equity markets. However, we remain cautious, as the broader economic context and potential for a recession cannot be ignored, especially given the early warning signs of economic weakness we have seen.

Our goal is to navigate this complex landscape with a focus on quality investments, disciplined risk management, and a long-term perspective. We encourage our clients to stay informed and engaged as we continue to provide insights and strategies tailored to their financial goals. Please watch our recent Quarterly Economic and Market Review video or join us for our upcoming CAISSA Office Hours to stay abreast of the latest thinking from our Investment Committee.

As always, we are here to support you through these changing times. If you have any questions or would like to discuss how these developments may impact your portfolio, please don’t hesitate to reach out to us.