Conventional wisdom regarding the Federal Reserve says easing efforts like interest rate cuts lead to stock market gains, and raising rates is generally seen as a negative for market bulls.
But what if it’s not that simple?
Oaktree Capital Management co-founder and co-chair Howard Marks thinks it’s more nuanced than that.
“Recent market reaction suggests investors are following their usual elementary take: weak economy → rate cuts → economic stimulus → stronger GDP → higher corporate profits → higher stock prices,” Marks wrote in his latest memo, which Warren Buffett calls required reading for investors.
Instead, Marks said, we should ask why the Federal Reserve is cutting rates.
“The answer, of course, is that the Fed anticipates economic weakness (or sees it taking place) and wants to ward it off,” he wrote. “So the second-level thinker wonders how bad the outlook is, how much worse it might have gotten without the rate cut, and whether the cut will be sufficient to avert a slowdown.”
Marks said the stock market and investors can’t see the forest for the trees, and are not taking into consideration the economic weaknesses that led to a rate cut to begin with, and that’s a big mistake.
“It’s worth noting that 18 months after that first rate cut in September 2007 — during which time ten more cuts followed, eventually taking the fed funds rate to nearly zero — the S&P 500 finally bottomed out, down more than 50% from where it stood on the day of the first cut,” Marks said.
Basically, if investors had decided to pile into the market after the first rate cut of 2007, they would have lost half of their money.
For that reason, Marks warns against knee-jerk reactions regarding the market.
“Finally, when I hear people talk about the possibility that the Fed will prevent a recession, I wonder whether it’s even desirable for it to have that goal,” Marks wrote. “Per the above, are recessions really avoidable or merely postponable? And if the latter, is it better for them to occur naturally or be postponed unnaturally? Might efforts to postpone them create undue faith in the power and intentions of the Fed, and thus a return of moral hazard? And if the Fed wards off a series of little recessions, mightn’t that just mean that, when the ability to keep doing so reaches its limit, the one that finally arrives will be a doozy?”