Why a Fed pause may be better for stocks than rate cuts

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Amid higher interest rates, investors have poured a record $1.4 trillion into money market funds in 2023 as they sought to earn roughly 5% on their cash.

But it might be time for that to end, according to BlackRock.

The Federal Reserve is expected to hold interest rates steady when it announces its next policy move on Wednesday. Markets are largely betting that the next time the Fed does take action on rates, it will likely be a cut.

This scenario would mean the Fed “pause,” which occurs between the hiking and cutting cycles, is already underway. And according to research from BlackRock Americas iShares investment strategy head Gargi Chaudhuri, the pause period is the time investors should own stocks versus collecting interest on their cash in money market funds.

Analysis from Blackrock shows equities, which are measured in this chart by S&P 500 performance, surge the most during the time between when the Fed finishes hiking interest rates and starts cutting rates.Analysis from Blackrock shows equities, which are measured in this chart by S&P 500 performance, surge the most during the time between when the Fed finishes hiking interest rates and starts cutting rates.

Analysis from Blackrock shows equities, which are measured in this chart by S&P 500 performance, surge the most during the time between when the Fed finishes hiking interest rates and starts cutting rates. (BlackRock iShares Investment Strategy)

“This might be a good time for investors to step out of cash,” Chaudhuri told Yahoo Finance Live.

Chaudhuri analyzed the returns in the S&P 500 (^GSPC) during the six months before the last hike, the pause period and the six months after the first cut for every Fed rate hiking cycle dating back to 1995. The analysis shows that out of the three, equities delivered their highest average annual return during the pause period.

“Whether you’re in the bond markets, whether you’re in the equity markets, investing in this pause period is really important,” Chaudhuri said. “And there is a little bit of urgency around it, because, eventually, we think by…the second half of 2024, the Fed will begin to cut rates.”

Chaudhuri sees opportunities in fixed income to take advantage of the “incredible” bond yields in markets as well as stocks. In stocks, she recommends “quality” stocks with low leverage, stable earnings growth and healthy balance sheets.

In a November blog post, eToro US Investment analyst Callie Cox reasoned that the 2023 flow into money market accounts made sense as interest rates rose and many felt uneasy about the path forward for the economy.

But, Cox said, its important to keep in mind a key caveat.

“Cash isn’t meant to sit under your mattress forever,” Cox wrote.

While less risky, over the long term cash misses out on potential opportunities in the stock market. Research Cox provided to Yahoo Finance shows stocks significantly outperformed cash during five of the last eight economic cycles (each cycle ends when an official recession is declared, which hasn’t happened since 2020).

A chat from eToro shows stocks have significantly outperformed interest earned by cash in five of the last eight economic cycles.A chat from eToro shows stocks have significantly outperformed interest earned by cash in five of the last eight economic cycles.

A chat from eToro shows stocks have significantly outperformed interest earned by cash in five of the last eight economic cycles. (eToro, Bloomberg)

Josh Schafer is a reporter for Yahoo Finance.

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