Good Evening! 👋

Welcome to Wealth Wednesday. We have big news in the finance world that impacts everyone in America and worldwide.

The Federal Reserve has started a new rate cut cycle with a 50 basis point (bps) cut.

You might be wondering, what does that mean for you, your investments, and the economy? Let’s break it down in simple terms.

Why Does the Federal Reserve Move Interest Rates?

The Federal Reserve (or the Fed) has two primary goals when it adjusts interest rates: to control inflation and support job growth.

The Fed typically raises rates when inflation is high to slow things down. This makes borrowing more expensive, which decreases spending and helps cool off rising prices.

But there’s a trade-off: slowing down the economy too much can lead to job losses and lower consumer demand.

On the other hand, when the economy is sluggish, the Fed cuts rates to encourage borrowing and spending.

Lower interest rates mean businesses can take out loans more easily to expand, and consumers can spend more on big-ticket items like homes, cars, and appliances. This stimulates the economy but can also risk driving inflation higher if things get out of hand.

It’s a delicate balance.

Let’s look at some real-world examples.

In the late 1970s, the Fed cut rates too soon in an effort to stimulate the economy. However, inflation soared back, leading to what many economists call a "lost decade" for both economic and investment growth. Prices skyrocketed, and the economy was in turmoil.

Then, in the early 1980s, Paul Volcker stepped in as Fed Chair and took drastic action to combat inflation. He aggressively raised interest rates to 20%, a move that crushed inflation for the next 40 years. However, this aggressive rate hike caused a mild recession, with unemployment rising and economic growth slowing.

Fast forward to 2008 during the global financial crisis, and the Fed took the opposite approach.

To pull the U.S. out of the Great Recession, the Fed slashed rates to near-zero levels. This helped stimulate the economy, but inflation became a concern in the years that followed.

Most recently, in 2022 and 2023, inflation surged to levels not seen in decades, and the Fed responded by raising rates aggressively. Mortgage rates soared, borrowing became more expensive, and housing sales cooled off. While this helped slow inflation, it didn’t solve the problem entirely.

So, when the Fed moves interest rates, it has a direct impact on the economy, on businesses, and on you.

How Do Interest Rate Changes Impact You?

Now that we know why the Fed adjusts rates, let’s examine how these changes affect your daily life.

When the Fed cuts interest rates, borrowing becomes cheaper.

That means mortgages, car loans, and credit cards often come with lower rates, saving you money on monthly payments.

So, a rate cut can be good news if you’re looking to refinance your home or take out a loan.

But there’s another side to this.

Lower rates can also mean lower returns on your savings. You'll likely see your interest earnings drop if you have a high-yield savings account or rely on income bonds.

For example, if you’ve been enjoying a 5% return on your savings, that could fall to 2% or less as banks lower their rates in response to the Fed’s cuts.

On top of that, inflation could also creep back in.

When borrowing becomes cheaper and spending increases, it can lead to rising prices. So, while you might save on loan payments, you could end up paying more for houses and automobiles.

Now, it’s also important to note that low-rate environments are typically bullish events for the stock market, particularly for risk-on assets like growth stocks.

For instance, during the 2010s, following the 2008 financial crisis, low interest rates fueled a massive bull market in tech stocks. Companies like Amazon and Netflix thrived in this environment, with their stock prices rising dramatically as low borrowing costs allowed these businesses to expand rapidly and investors sought out high-growth opportunities.

Another example is Tesla, whose stock exploded in a low-rate environment as investors were willing to pay a premium for the company’s future growth potential.

However, as we’ll discuss below, this rule has some key exceptions.

It’s all interconnected—interest rates, inflation, and your personal finances.

Historical Trends of 50 bps Rate Cuts

This recent 50 basis point rate cut marks only the third time in modern history that the Federal Reserve has kicked off a rate cut cycle with such an aggressive move.

The previous two instances—2001 and 2007—led to economic downturns and market crashes.

In 2001, the Fed tried to counter the dot-com bubble burst with a 50 bps cut, but it wasn’t enough to prevent a deep bear market. The Nasdaq dropped dramatically, wiping out years of gains in tech stocks.

Then 2007, as the housing bubble began to burst, the Fed again started with a 50 bps cut.

The result?

A massive financial crisis sent markets tumbling, with the Nasdaq losing more than half its value.

While history shows that such aggressive rate cuts can signal economic distress, it’s important to note that each situation is different.

Tech stocks are soaring in 2024, and the Fed maintains that the economy is strong.

What Should Investors Do?

Now comes the big question: What should you do as an investor when the Fed cuts rates and market conditions are uncertain?

First off, don’t panic.

Market downturns and volatility are part of the investing journey, and long-term strategies often win out.

Warren Buffett, one of the most successful investors of all time, is a firm believer in staying calm during market downturns.

He often says that "the stock market is designed to transfer money from the impatient to the patient." 

Buffett emphasizes that market downturns can present opportunities to buy great companies at discounted prices.

He also warns about the long-term effects of inflation, noting that it can silently erode wealth over time. His advice?

Focus on businesses with strong fundamentals that can weather economic storms and pass on rising costs to consumers without losing their competitive edge.

Another legendary investor, Seth Klarman, has also weighed in on market volatility and inflation.

He’s known for saying that “investing is the intersection of economics and psychology.”

Klarman encourages focusing on value, knowing that in times of uncertainty, market prices can often undervalue strong companies.

There are always undervalued opportunities in any market, even when the headlines are grim or great!

Take Goldman Sachs during the 2008 financial crisis. The stock was beaten down as the market panicked, but for those who could see its long-term value, it was a prime opportunity. Goldman Sachs weathered the storm and came back stronger, rewarding patient investors with substantial gains.

More recently, look at Meta (formerly Facebook) in 2022. The market was doing relatively well, but Meta’s stock plummeted to $113 after one disappointing earnings report. Many saw it as a disaster, but savvy investors recognized the company’s potential. Fast forward to 2024, and Meta is now trading around $537—a remarkable turnaround in just two years.

This is where strategies like dollar-cost averaging come in. Instead of trying to time the market, you invest a fixed amount of money at regular intervals, whether the market is up or down.

For example, if you had invested $500 a month in Meta during its downturn, you’d now be sitting on substantial gains without the stress of guessing when to buy or sell.

The key takeaway? Even in tough markets, there are opportunities. It’s about staying patient, finding undervalued assets, and sticking to a strategy.

Conclusion

The Federal Reserve’s recent rate cuts are making headlines, and for good reason. When the Fed starts a rate cut cycle with a 50 basis point cut, it’s often a signal that big changes are coming.

Historically, these cuts have preceded economic downturns, as seen in 2001 and 2007. But today’s environment is different—tech stocks are soaring, and the Fed insists we’re not headed for a recession.

The big question now is whether the Fed can make history by avoiding a recession after such an aggressive start to rate cuts.

As an investor, the best thing you can do is stick to your long-term plan, focus on dollar-cost averaging, and look for opportunities in undervalued stocks.

Talk to you on Sunday!

Cheers,

The Bean Team

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