Fed rate cuts always lead to stock-market gains — but this one thing must happen

It’s way too early to proclaim a Goldilocks environment, even if major asset classes are at least pointing to a better chance of it. The S&P 500

has gained 5% this year, and the tech-heavy Nasdaq Composite

is up 8%, even with a seemingly daily stream of job-cut announcements. Stay tuned Thursday to a barrage of economic data.

Veteran Wall Street strategist Joe Lavorgna is certainly in the camp expecting a recession.

“The key indicators we track are all flashing recession such as the index of leading economic indicators, housing starts and the Treasury yield curve to name just a few. These indicators have turned over as the economy is still absorbing rate hikes and balance sheet shrinkage,” says Lavorgna, now chief economist at SMBC Nikko Securities America, and the former chief economist of the White House National Economic Council.

But Lavorgna allowed for the possibility that the economy will escape a recession. And, crunching the numbers, he found an impressive historical track record. For every period when the Fed initially cut interest rates and recession was avoided, the S&P 500 was higher, after three, six and 12 months.

The best period was after the Russian debt default/LTMC crisis of July 1998 — after the Fed cut that September, stocks rose nearly 26% over the 12 months. As the chart shows, the market on average rose by double digits after the reductions.

“But for the stock market to produce such impressive results, the economy needs to avoid a hard landing. Otherwise, the probabilities favor lower prices sometime over the months ahead. Given this binary situation — recession or no recession — it is understandable why market participants are so fixated on the macroeconomic data,” he says.

Dhaval Joshi, chief strategist of BCA Research’s Counterpoint, says the trouble for investors is knowing whether the economy is in a recession, because gross domestic product is released so many weeks after the quarter’s mid-point.

Instead, he likes to use U.S. retail sales divided by average hourly earnings, as a proxy for corporate profits. Whenever the ratio between them falls by 3.5% from its peak, the unemployment rate goes on to rise at least 0.6% — and once the jobless rate rises by at least 0.6%, it never fails to eventually rise over 2%, over the last 75 years.

That ratio is getting pretty close the point of no return — down just over 3% from its peak.

He added that the resilience, so far, of the jobs market makes sense, because companies wait until profits fall to start cutting jobs. In the one industry where profits are falling, technology, they are indeed laying off workers.

Joshi advises remaining defensive on a six to 12 month horizon, by overweight bonds to stocks, healthcare versus technology, gold versus oil, and the Japanese yen versus the euro. And he said Feb. 15 will be a crucial date — when the next retail sales report comes out.

The market

U.S. stock futures


were mostly higher ahead of the data onslaught. The yield on the 10-year Treasury

was 3.48%. Oil

was trading just under $81 per barrel.

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The buzz

Fourth-quarter gross domestic product data is due, alongside weekly jobless claims, durable-goods orders, the advanced trade in goods report and after the open, new-home sales.


Read More: Fed rate cuts always lead to stock-market gains — but this one thing must happen

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