What is the impact of interest rate cuts on the stock market? A comprehensive look at four types of profitable stocks

September 18, the Federal Reserve announced its first interest rate cut of 50 basis points, setting the target range between 4.75% and 5.00%, ending the rate hike cycle that began in March 2020. This move has attracted significant attention from global investors: under the new round of interest rate cuts and their impact on the stock market, can the US stock market usher in an upward trend?

Why are central banks starting to cut rates?

Shifts in interest rate policies usually stem from specific economic signals. The driving factors behind this round of US rate cuts are worth noting:

Labor market pressure—Unemployment rate has continued to rise from 3.80% in March 2024, reaching 4.30% in July, breaking the recession warning line of the Sam rule. Although it slightly declined to 4.20% in August, the upward trend is clear, indicating the employment market is shifting from tightness to looseness.

Manufacturing sector in trouble—ISM Manufacturing PMI has been in contraction for five consecutive months, reflecting weakening real economic activity. As a result, the Fed lowered its full-year GDP growth forecast from 2.1% to 2.0%.

Easing inflation pressures—Price increases have fallen back into the central bank’s comfortable range, creating conditions for rate cuts.

Generally, central banks consider lowering interest rates in scenarios such as: economic slowdown leading to rising unemployment; emergence of deflation risks; financial market turbulence threatening systemic stability; external economic shocks transmitted domestically; or in response to sudden events like pandemics.

Historical perspective: how do stocks perform after rate cuts?

Goldman Sachs macro strategist Vickie Chang pointed out that since the mid-1980s, the Fed has implemented 10 rounds of rate cuts. Among them, 4 were associated with recessions, while 6 were not related to downturns. The key finding is: when the Fed successfully prevents a recession, stocks tend to rise; when a recession is unavoidable, stocks often decline.

The following four cases demonstrate the actual effects of rate-cutting policies:

Case 1: Dot-com Bubble Burst (2001-2002)

Rate cuts failed to save expectations from collapsing

Facing the bursting of the dot-com bubble and economic slowdown, the Fed began cutting rates in January 2001. However, corporate earnings expectations were sharply revised downward, and the overvalued tech stocks could not be reconciled. The Nasdaq index plummeted from 5048 points in March 2000 to 1114 points in October 2002, a 78% decline; the S&P 500 fell from 1520 to 777, nearly a 49% drop. The rate cut policy had little effect on a market that had already lost confidence.

Case 2: Financial Crisis (2007-2008)

Limited effectiveness of rate cuts during systemic risk outbreak

The Fed gradually raised rates from 2004 to 2006 to 5.25%, trying to curb the overheating housing market. But in 2007, the subprime mortgage crisis erupted, banks faced difficulties, and credit froze. Subsequent rate cuts faced a deep recession, rising unemployment, waves of corporate bankruptcies, and sharp reductions in consumer spending, limiting their impact. The S&P 500 dropped from 1565 in October 2007 to 676 in March 2009, a decline of over 57%; the DJIA fell from 14164 to 6547, about a 54% drop.

Case 3: Preemptive Easing (2019)

Moderate rate cuts effectively boosted the market during economic stability

In July 2019, the Fed adopted a preemptive rate cut amid concerns over global economic slowdown and trade tensions. This was interpreted by the market as a signal of support for continued economic expansion. Coupled with resilient corporate profits, strong tech sector performance, and progress in US-China trade negotiations, the S&P 500 rose 29% for the year, from 2507 to 3230; Nasdaq increased 35%, from 6635 to 8973.

Case 4: Unconventional Rate Cuts during Pandemic Shock (2020)

Massive liquidity injection accelerated economic rebound

The outbreak of the pandemic caused a sudden halt in economic activity, with unemployment soaring. The S&P 500 plunged from its February high of 3386 to a March low of 2237, a 34% decline. The Fed quickly implemented two emergency rate cuts in March, lowering rates to 0-0.25%, and launched quantitative easing. Abundant liquidity, accelerated digital transformation, and successful vaccine development jointly drove the market rebound, with the S&P 500 ending the year at 3756, up 16%; Nasdaq gained 44% for the year.

Which stocks perform best during rate-cut cycles?

Analysis of past rate-cut cycles reveals clear sector rotation patterns:

Technology stocks: biggest winners—Low interest rates increase the present value of future cash flows and reduce financing costs, encouraging R&D and expansion. During optimistic economic outlooks, tech stocks surge notably. In the 2019 rate-cut cycle, tech stocks rose 25%, and during the emergency cuts in 2020, they surged up to 50%.

Consumer discretionary: demand-driven beneficiaries—Lower rates boost consumer spending, benefiting auto, home, and luxury goods sectors. In 2020, these stocks rose 40%, and in 2019, 18%.

Healthcare: defensive growth—This sector combines resilience to economic cycles with endogenous growth. During rate-cut periods, healthcare stocks tend to rise steadily; in 2020, up 25%.

Financials: complex interest margin logic—Initially pressured by narrowing net interest margins during rate cuts. In 2001 and 2019, early rate cuts saw financial stocks perform modestly, but in 2020, amid economic recovery expectations, they rebounded to 10%. During the 2008 crisis, financial stocks fell sharply, by about 40%.

Energy: policy marginal effects—Rate cuts can stimulate economic activity and boost oil demand, but geopolitical factors and oil supply are dominant. These stocks tend to be highly volatile during rate cycles, with even a -5% change in 2020.

The table below compares sector performance 12 months after each rate cut cycle:

Key observations on rate cuts in 2024

Fed Chair Powell stated on September 30 that subsequent rate cuts are not aggressive, with an expected further 50 basis points reduction this year. The market generally anticipates a 25 basis point cut at each of the November and December FOMC meetings.

The remaining two FOMC meetings this year (November 7 and December 18) will be critical windows for the direction of interest rate policy. Close monitoring of unemployment, manufacturing data, and inflation indicators is essential, as these will directly influence the Fed’s rate cut pace.

The dual effects of rate cuts

Positive effects—Lower borrowing costs stimulate consumption and investment. Interest expenses for indebted households and businesses decrease, improving cash flow. Financial markets enjoy ample liquidity, reducing systemic risks.

Risks and concerns—Prolonged low interest rates may lead to overinvestment, rising prices, and asset bubbles. Once bubbles burst, financial crises can ensue. Long-term ultra-low rates encourage excessive leverage, increasing household and corporate debt, and heightening financial vulnerabilities.

Overall, the impact of rate cuts on the stock market depends on economic fundamentals. If the Fed successfully prevents a recession, rate cuts tend to have a positive effect on stocks; if a recession worsens, rate cuts often have a negative impact. Investors should select high-elasticity assets like technology and consumer sectors to participate in the benefits of rate cuts according to the economic cycle.