The S&P 500 was down five days in a row heading into Friday of last week, although the losses were fairly minor with only one day down more than 0.5% (and that one barely). Then Jerome Powell opened the door for a rate cut in September and the bulls stepped up in a historic way. We will discuss exactly what he said and what it means for future policy in a bit, but first let’s look at the stock market implications.
The S&P 500 just missed a new all-time high Friday, but the Dow hit its first new high of 2025, and we saw huge moves higher from micro caps and small caps (areas that like lower interest rates). Under the surface it was a historic day, as most stocks were higher and most of the volume as well.
Friday Was Rare and Potentially Very Bullish
Friday was a rare “90/90 day,” which means more than 90% of the stocks on the New York Stock Exchange (NYSE) were higher, with more than 90% of the volume on the NYSE higher as well. Historically, we’ve seen this type of day near major lows, with the last two times coming off the near-bear market lows in April and off the COVID bear market low in 2020.
Looking at the data, we found that the S&P was higher a year later 11 out of 12 times after a 90/90 day, with an average gain of more than 23% on average. The shorter-term returns are much better than average as well. We’ve long said this is still a major bull market, and Friday’s action does little to change our tune.
Long Waits Between Cuts Can Be Bullish
“The waiting is the hardest part.” — Tom Petty
Last week we noted that the Fed has cut rates with stocks near all-time highs before. Indeed, that can be a very good sign, as stocks were higher a year later 20 out of 20 times. Then add in the three cuts near all-time highs (ATHs) late last year, and this very well could be 23 for 23 when all is said and done. No, we don’t know if the Fed will cut in September or if stocks will be near ATHs then. Still this is something to prepare for in our opinion.
The other thing that caught our attention last week while thinking about the Fed is how long it has been now since thee last rate cut. They cut three times for a total of 1.00% late last year. Should they cut next month that would be nine long months since they last cut (a 0.25% cut on December 18, 2024).
We found all the other times the Fed took a long pause in between cuts and the good news is just like Tom Petty told us, the waiting was the hardest part, but it was worth it.
Looking at pauses between 5 and 12 months, we found that stocks were higher a year later 10 out of 11 times with a very impressive median return of 14.5%. Yes, 2001 is in there (skewing the returns), but that time of course was when the tech bubble was collapsing, with 9/11 and a recession on the horizon. The majority of the other times saw solid gains a year later, with 7 out of 11 times up more than double digits.
Bottom line, we could get some seasonal weakness at any time, but we are in a major global bull market and continue to believe any weakness is likely to be short lived.
Powell Opens the Door to Rate Cuts
Federal Reserve (Fed) Chair Jerome Powell’s speech at Jackson Hole was the event of the week and with good reason, as investors expected it to signal the direction of monetary policy over the coming months, especially whether the Fed would hold or cut rates at their next meeting in September. And it does at least seem like Powell is ready to cut rates.
Powell did note that risks to inflation are tilted to the upside, but also noted that risks to employment are tilted to the downside. This is challenging given the Fed must balance both sides of its mandate (stable inflation and maximum employment). But here’s the key: Powell also pointed out that policy rates are in restrictive territory and that means “the shifting balance of risks may warrant adjusting our policy stance” (quoting directly from his speech). This is dovish on balance and markets ran with it, with the S&P 500 surging 1.5% on Friday after the speech and rate sensitive areas jumping even more:
- The small cap Russell 2000 Index gained 3.9%.
- The SPDR Homebuilders ETF (XHB) gained 5.1%.
Now for the nuance, and there’s plenty of it. The Fed has now been on pause since last December, and by their own admission, this is because of the uncertainty tariffs have imposed on the inflation outlook. If not for tariffs, they’d have cut rates months ago, plain and simple. With his Jackson Hole comments, Powell certainly opened the door to a cut in September, but that’s all it was. For perspective, in his speech last year, Powell was much more explicit that they were going to cut rates, saying “the time has come to adjust monetary policy.” That’s very different from saying that a policy adjustment MAY be warranted. In short, this means two things:
- A rate cut in September is likely, but it’s not a certainty.
- The path ahead is very uncertain, and this is not a signal that even a September cut is the beginning of a series of cuts (like in 2024).
Market expectations reflected this, with the probability of a cut in September rising from 75% to 85% by the end of the day. In other words, there’s confidence that a cut is coming but it’s not a certainty. In fact, rate cut pricing is back to where it was after a hot Producer Price Index (PPI) report released the prior week, but not as high as the 100% probability after the better-than-expected Consumer Price Index (CPI) data.
Data Dependence
If Powell wanted to clearly signal a rate cut in September (and beyond) he could have, as he did last year. At the same time, if he wanted to signal no rate cut, he could have done that too. He did neither. Instead, it’s going to come down to the data, and crucially there are two important data points that we’ll get before the next Fed meeting in September: the August payroll data on Friday, September 5, and the August inflation readings on Thursday September 10 (PPI) and September 11 (CPI).
If the data points to a weakening labor market, we’ll get a cut and maybe a couple of more this year. The wrinkle is inflation, and that may matter more for the rate cut outlook beyond September. For now, it looks like Powell is willing to look past the inflation data given tariff impacts are likely to be one-offs, and the fact that he doesn’t think higher inflation is being caused by a tight labor market and strong wage growth.
There’s divergence within the Fed as well. A couple of governors (Chris Waller and Michelle Bowman) are clearly on the dovish side, with Powell and San Francisco Fed Chair Mary Daly looking to be buying into their arguments. However, there are several on the other side who are more worried about recent inflation data, including Jeff Schmid (Kansas City Fed), Austan Goolsbee (Chicago Fed), Susan Collins (Boston Fed), and Beth Hammack (Cleveland Fed, but not a voting member of the committee this year). Back in June, the median Fed member projected 2 cuts in their outlook for 2025. However, 7 out of 19 members projected zero cuts. Granted, this was before the weak payroll numbers we got for July (and the downward revisions for May and June), but it was also before recent inflation data showing the numbers going the wrong way. All this to say, there’s a lot of divergence within the Fed given members’ different interpretations of the data, and this is likely why markets are still pricing in just about two cuts in 2025—in line with the median Fed member.
To be clear, the justification for a rate cut (or more) is economic weakness. And the clearest sign of weakness is the monthly payroll data, which is currently averaging just 35,000 over the last three months. At the same time, other labor market data paints a different picture:
- The unemployment rate at 4.25% is still historically low.
- Layoffs are running really low, whether you look at a timely indicator like initial claims for unemployment benefits or even the layoff rate (layoffs as a percent of the workforce), which is at a historically low level of 1%.
- The hiring rate of 3.4% (hires as a percent of labor force) is the weakest it’s been since 2014 (excluding Covid) but it hasn’t really gotten worse this year.
- The quits rate, which measures voluntary quits as a percent of the workforce, has risen from 1.9% at the end of 2024 to 2.1% in June. (The quit rate would be falling, not rising, if the labor market were really weak and workers were worried about finding a new job if they quit their current one.)
- The vacancy rate, which is job openings as a percent of the labor force and a measure of demand, has also stabilized around a reasonably strong rate of 4.5%.
- Wage growth is running around 3.5-4%, close to pre-pandemic levels, and as such it doesn’t point to extreme weakness in the labor market.
Now if weak payroll data is providing an early signal of weakness we could very well see the above measures go south in a non-linear way (that is, fast)—and that’s the argument for at least an “insurance cut” in September. At the same time, the massive drop-off in immigration means the economy may only have to create about 50,000 jobs to keep up with payroll growth. In other words, there may be reasons to be wary of the story told by payroll data, especially during periods when there are significant population shifts. This also applied in 2023–early 2024, when payroll growth was averaging above 200,000 per month (even after revisions), but those numbers were a function of higher immigration more than anything else.
A Long-Term Dovish Posture = Bullish for Markets
Powell also made some important remarks regarding how the Fed will go about pursuing monetary policy more generally going forward. Five years ago, they shifted their framework to something called “flexible average inflation targeting” (FAIT). Long story short, it meant that if inflation ran well below their target of 2% for a long time (like in the 2010s), they’d shoot for “above average” inflation to “make up” for the shortfall. Of course, we all know what happened with inflation after 2021.
On the other side, FAIT would also imply that if inflation ran above target for a while, the Fed would shoot for below target inflation in the future, i.e. keep monetary policy more restrictive to “make up” in the other direction. But FAIT was never likely to be symmetric in this way, and Powell confirmed that in his speech. They’re now doing away with it and going back to targeting deviations from their target, as they did from 2012–2020.
Combine this with the Fed’s likely willingness to do an insurance cut to protect labor markets even as core inflation is running above their target (for 52 months now) and going in the wrong direction, and the outlook is dovish. Looking at the Fed’s preferred personal consumption expenditures metric (PCE), and breaking it into two important pieces, durable goods and services:
- PCE for durable goods is up 0.9% year over year (as of June), which is higher than anything we saw from 1996–2020. In fact, the average inflation rate for durable goods was -1.9%.
- PCE for durable goods is running at 3.5% year over year and has stopped going down. That’s really elevated relative to the average of 2.5% from 1996–2020. (It averaged 2.9% from 1996–2008 and 2.1% from 2009–2020.)
Keep in mind that the president is also inclined to shape the Federal Reserve in such a way so that they pursue lower interest rates and run the economy (and inflation) hot. Add to this, deficit-financed tax cuts that will not entirely be offset by tariffs. Folks, inflation may not go back to the Fed’s 2% target for a long time, unless we see a deflationary recession.
All of this is quite bullish for equities, and the picture jives with our longer-term strategic outlook (and even our shorter-term tactical views):
- Overweight equities – keep in mind that stocks also protect against inflation over the long run.
- Neutral US vs international stocks as we look to diversify away from the dollar.
- Underweight bonds, and overweight alternative assets like managed futures and gold, as we expect more inflation volatility in the future.
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