Fed Rate Cuts Set Stage for S&P 500 and Small-Cap Rally
The FOMC cut interest rates, but the media response indicated that the cuts were less than expected. However, the headlines focused on next year’s tepid outlook for only 25 basis points of cuts are missing the forest for all the trees. While next year’s outlook is tepid, the forecast for another 50 bps of cuts this year is aggressive.
The takeaway is that the FOMC is planning to cut rates by 100 bps between September 2025 and, potentially, mid-year 2026, providing financial relief throughout the system. The first impacts will be minor; it will take time for them to compound, but, with rates set to fall significantly within a short timeframe, tailwinds can begin to form within the economy.
This is all good news for the S&P 500 NYSEARCA: SPY.
The index, which is impacted by news but led by earnings, was already forecasted to grow earnings over the following six quarters and accelerate growth over the next three to four quarters.
The outlook is brightening, illuminating a more straightforward path to higher index prices. The likely outcome is that upcoming earnings reports, specifically the guidance, will be better than expected and lead to bullish analyst revisions for individual stocks, sectors, and the index at large.
The technical outlook for the index is robust.
The S&P 500 targeted levels between 7,400 and 7,600 when it hit new highs earlier this year, and those targets have been confirmed after the rate cut. The initial market reaction was lukewarm; the index stayed steady at existing highs but then moved higher in the next session to reach another new high, speeding up the rally.
Tech Will Continue to Lead This Market Higher
Businesses will feel the first benefits of the cuts, and the tech sector is primed for an increase in capital flow. NVIDIA NASDAQ: NVDA, thanks to its AI advantage, is in the best position, but spending has already begun to bleed into other names.
The megacap AI infrastructure companies are benefiting, and smaller, application-focused AI companies like Snowflake NYSE: SNOW and Workday NASDAQ: WDAY have also started to show renewed momentum.
They provide numerous benefits to businesses by simplifying complex tasks, reducing costs, driving revenue, and strengthening margins and are expected to grow robustly over the next five to ten years.
Small caps will also gain favor. Declining interest rates will boost all smaller companies, not just tech, and will drive the sector rotation that began in 2024.
The Russell 2000 INDEXRUSSELL: RUT was among the biggest movers following the FOMC announcement, gaining more than 2% the day after the announcement to set a record high.
Assuming the market follows through on this signal, the small-cap index could advance 700 points or as much as 30% at the low end of the target range and up to 40% at the high-end range by the middle of next year.
Consumer Spending Will Be Better Than Expected
The forecasts for 2025 holiday spending are the worst in years, expecting a mid-single-digit decline, but they may be overly cautious.
The Fed’s rate cut will improve consumer sentiment, if nothing else, and potentially lead to better-than-forecast results. The consumer staples and discretionary sectors are expected to grow tepidly in 2025, contracting in Q3 and Q4, before reverting to growth in 2026.
The more likely scenario is that consumer staples grow tepidly in the back half, outperforming the full-year consensus, and then accelerating next.
The question is what happens with the housing market. The housing market has been virtually frozen for years and may begin thawing with rates falling, stimulating economic activity and consumer spending in 2026.
At 5.5%, compared to mid-September’s 6.25%, a 30-year mortgage rate may be low enough to spark a housing market boom and usher in another golden age for the builders.
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