The Federal Reserve has recently resumed cutting interest rates after maintaining a steady monetary policy for an extended period, a move that has historically been favorable for the stock market. This month, the S&P 500 index has shown remarkable resilience, having advanced 13% year-to-date and reaching record highs on more than two dozen occasions.
This robust performance was unexpected just a few months ago when President Donald Trump imposed significant tariffs, raising concerns among analysts. However, various factors, including increased spending on artificial intelligence, contributed to more than a percentage point boost in GDP growth during the first half of 2025. Additionally, corporate earnings exceeded expectations, particularly in the technology sector, further alleviating investor concerns.
Historically, the stock market tends to thrive when the Federal Reserve begins to cut rates after an extended pause. On September 17, the Fed decreased its benchmark interest rate by a quarter of a percentage point, marking the first rate cut since December 2024. Prior to this, the Fed had entered a pause in the cutting cycle following the announcement of President Trump’s tariffs, which had led to a wait-and-see approach. Policymakers balanced the risks of potential inflation from tariffs against the possibility of weakened job growth. Ultimately, job growth appeared to suffer, resulting in an average addition of only 27,000 jobs per month from May to August— the slowest growth in that timeframe since 2010, excluding the pandemic.
According to data from Goldman Sachs, when the Fed has cut rates after maintaining them for at least six months—something that has occurred only eight times since 1985—the S&P 500 index has historically seen a median return of 13% over the following year. In instances where no recession followed the cuts, the median return was even higher at 16%. Based on this historical data, the index, which closed at 6,600 on the day of the rate cut, could potentially reach 7,458 within a year if it reflects the average trend.
Despite the optimism surrounding potential market gains, caution is advised. As per FactSet Research, the median 12-month target price for the S&P 500 is projected to be 7,310, indicating a 10% upside from its current standing of 6,632. However, companies within the index may face slower earnings growth in the latter half of 2025, driven by the impact of tariffs on profit margins. Moreover, inflation has begun to rise, with the Consumer Price Index hitting 3.1% in August, up from 2.8% in May, which could further affect economic conditions.
Currently, the S&P 500 trades at a forward price-to-earnings ratio of 22.5, a valuation seen only during notable periods like the dot-com bubble and the pandemic, both of which resulted in market crashes. This raises concerns about the potential for significant downturns should the economic outlook worsen or if companies deliver disappointing earnings in upcoming quarters.
In light of these various factors, investors are encouraged to be prudent. It is advisable to steer clear of stocks with inflated valuations, particularly those of unprofitable companies. Investors should focus on purchasing shares of high-conviction ideas and reasonably priced stocks that are expected to see substantial earnings growth in the coming years. Furthermore, maintaining liquidity by accumulating cash in their portfolios is recommended, allowing investors to take advantage of potential market downturns as they arise.
