The Federal Reserve’s bold 0.50% interest rate cut at the conclusion of its two-day meeting last week landed like a mic drop after a show-stopping performance. Investors applauded, with the S&P 500 and Dow Jones Industrial Average scaling new heights.

As rates continue to drop, some of the most battered sectors are staging a comeback that’s poised to continue into 2025. Below, I’ll show you how to trade under these conditions.

After the most aggressive round of rate hikes in four decades and the second-longest period of holding rates steady in restrictive territory, the Fed last Wednesday finally cut rates for the first time in four years.

However, instead of the usual 0.25% trim, the Fed went for a more robust 0.50%, lowering the target range to 4.75%-5.0%. Chair Jerome Powell had hinted at an aggressive cut during the Jackson Hole economic symposium last month. To Wall Street’s surprise, Powell and his crew delivered.

The decision wasn’t driven solely by inflation, which has dropped from its peak of 9.1% in June 2022 to 2.5% in August, as measured by the headline consumer price index (CPI). Unemployment now hovers at 4.2%, still low by historical standards but on a gently rising path that reflects deflationary trends.

The Fed is juggling a dual mandate: price stability and full employment. So far, the central bank has performed an admirable balancing act.

The hefty rate cut has political ramifications, of course, because it will juice the economy ahead of the November 5 election. But that doesn’t mean the move was politically motivated. Partisan critics are predictably accusing Powell of being in cahoots with the Democrats. For the record, Powell is a registered Republican and a Trump appointee.

The bond market barometer…

As I frequently counsel my readers, look to the bond markets. The bond markets are barometers of economic and policy changes.

A rising yield can indicate expectations of higher interest rates, while falling yields suggest the opposite. Yields have been falling recently, as bond traders priced in the Fed’s cut.

Central banks around the world already had been slashing rates, making the Fed an outlier that came late to the loosening party. It’s clear the Fed wants to avoid being too restrictive for too long, even if it means going big now and reverting to smaller cuts later.

This isn’t the first time the Fed has pulled the 0.50% trigger. The last times were in response to crises: the pandemic in 2020, the financial meltdown in 2008, and the dot.com bust in 2001. What’s different now? The Fed is acting not because it has to, but because it can. It’s more of an insurance policy to keep the economy humming and avoid an employment implosion.

With consumer spending still robust, low jobless claims, and record-high household net worth, a soft landing seems not just possible, but probable. Accordingly, equity markets finished last week on a strong note, as the following chart shows:

Don’t think this is a one-and-done situation. Last week’s rate cut is just the opening act of what’s likely to be a years-long easing campaign. The Fed’s latest “dot plot” shows plans for additional cuts this year, most likely in quarter-point increments.

The path forward suggests a series of reductions, with the goal of reaching a neutral rate by 2026. The neutral point is around 2.9%, and while the exact journey depends on incoming data, the trajectory is clear—borrowing costs are headed lower, likely reviving growth later in 2025 after a potential soft patch. Get your portfolio into position, now.

Historically, when the Fed cuts rates outside of a recession, stocks tend to thrive. We’ve seen this before in the cycles starting in 1984, 1989, 1995, and 1998. On the other hand, when rate cuts come amid economic downturns, markets tend to struggle—think 1981, 2001, and 2007.

Given current conditions, it seems to me that this cycle resembles the non-recessionary periods of the past. The last time stocks were riding high when the Fed started cutting was 1995, and the S&P 500 surged 23% over the following year.

Valuations today are on the higher side, which means the upside might not be as dramatic. However, the outlook for equities remains positive as long as the economy holds steady.

We’ve already seen a shift in stock market leadership, with sectors such as real estate, utilities, and financials outperforming the technology names that dominated during the tightening phase. The tech-heavy NASDAQ has lagged the broader S&P 500 over the past three months, and growth stocks are trailing value stocks.

Now that it’s apparent a recession has been avoided, I believe cyclical and lower-valuation stocks will close the gap with tech giants. Dividend-paying stocks, particularly those among the S&P 500 Dividend Aristocrats, should become more attractive as bond yields drop. And small-cap stocks, which offer a sweet spot between quality and growth, have room to catch up as the economy reaccelerates in 2025.

In the bond market, lower rates also spell opportunity. Investment-grade bonds have historically delivered strong returns in the year following the start of a Fed rate-cutting cycle. With bond yields near their lows, the potential for further declines suggests that longer-term bonds could provide value.

On Monday, the main U.S. stock market indices closed mostly higher as follows:

• DJIA: +0.15%
• S&P 500: +0.28%
• NASDAQ: +0.14%
• Russell 2000: -0.34%

Once again, the Dow and S&P 500 hit record highs.

The week ahead…

In the coming days, the following economic reports are scheduled for release:

S&P flash U.S. services and manufacturing PMIs (Monday); S&P Case-Shiller home price index, consumer confidence (Tuesday); new home sales (Wednesday); initial jobless claims, durable goods orders, gross domestic product (second revision), pending home sales (Thursday); personal consumption expenditures index (PCE), consumer sentiment (Friday).

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John Persinos is the editorial director of Investing Daily. You can reach John via mailbag@investingdaily.com

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