Why in the second semester attention is needed
Stocks tend to rally just before and after the first rate cut, when the "relaxation" is driven by the normalization of monetary policy. Goldman Sachs looks at what's happening in the current cycle and how similar it is to previous cycles, as well as how a rate cut will affect markets.
The table below shows the returns of the S&P 500 over 12 months along with macroeconomic conditions (growth, inflation, labor market, private sector leverage) and market conditions (the Fed rate, stock and US dollar valuations, etc.) in beginning of the Fed's rate-cutting cycle, in the total of ten cycles since 1984.
For this year's cycle, G.S. captures the current values (either predicted or most recent) for the same variables.
While there are similarities to some cycles in some aspects, no cycle stands out as being very similar to the current environment. Goldman expects this to be a non-recessionary tapering cycle driven by policy normalization, so the obvious analogous cycles are those marked in green (1984, 1989 and 1995). According to previous analysis by the US bank, these are environments that have positive returns for stocks a year after the start of interest rate cuts.
As the US bank points out, the upcoming easing cycle is likely to take place in a context where GDP growth has been relatively strong, the unemployment rate is low, there are no obvious imbalances in the economy and inflation is approaching target levels. On the market side, equity valuations are high, the dollar is also somewhat overvalued, and markets are pricing in significant material future easing.
Compared to the three previous rate-cutting cycles that had policy normalization as cause and effect, the current one is more like those of 1989 and 1995 than 1984, both of which saw fairly positive stock returns in the year after the first decline, as Goldman notes.
Both of these cycles occurred during a period when economies were robust with no apparent imbalances. Both equity and dollar valuations are richer than they were then, but those two previous episodes also started with equity valuations that were somewhat inflated relative to the macro environment, which didn't prevent double-digit 12-month returns after the first reduction.
An alternative approach is to examine expected macroeconomic dynamics and their historical relationships with stock returns. And that approach suggests stock returns will be modestly positive on an annualized basis from now on, according to G.S.'s new target. for the S&P 500 at the end of 2024, which is 5,200 points.
The clearest positive environment for risk assets, according to Goldman Sachs, is the next 3-6 months, where falling structural inflation and bond yields are more pronounced in its forecasts.
After the summer, risks surrounding the US election, the possibility that the Fed will cut less than the market expects if the economy responds well to the initial easing, and even richer stock valuations, may create a more complicated outlook for risk assets, emphasizes the American bank.
Therefore, based on the above, Goldman Sachs' core market strategy remains risk-on, but expects periodic corrections along the way, given the positives the market has already priced in. History also shows that the worst outcomes for the market may only be possible if there is another major shock.