US Stocks Are Seeking a Fed Cut Playbook Amid the $14 Trillion Stock Rally

A $14 trillion surge that has propelled U.S. equities to record territory is approaching a pivotal moment, with Wall Street watching closely as the Federal Reserve is widely expected to resume interest-rate cuts at its upcoming policy meeting.

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The S&P 500 has climbed 32% from its April lows, lifted by investor confidence that borrowing costs will fall multiple times this year. A quarter-point cut on Wednesday is seen as virtually guaranteed.

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For bullish traders, history may offer reassurance: according to Ned Davis Research, since the 1970s the index has averaged a 15% gain in the year following rate cuts that resumed after a pause of six months or more. That compares to a 12% gain after the first cut in a more typical cycle.

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The lingering concern is whether the Fed acted soon enough to prevent a sharper downturn. While growth and corporate earnings remain solid, warning signs have emerged. The latest jobs report showed unemployment climbing to its highest since 2021, raising fears that the labor market is weakening faster than expected. Investors are taking varied approaches to the shift, from betting on small-cap stocks that stand to benefit from lower rates to sticking with the megacaps that have driven much of the rally.

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“We’re in a very unusual environment,” said Sevasti Balafas, CEO of GoalVest Advisory. “The key questions are how much the economy is slowing and how aggressive the Fed will be in cutting rates. It’s a complicated puzzle for investors.”

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All eyes will turn to the Fed’s policy announcement Wednesday at 2 p.m., followed by Chair Jerome Powell’s press conference 30 minutes later. Traders will focus not only on the immediate rate move but also on the central bank’s updated quarterly projections the so-called dot plot for clues on the pace of easing ahead.

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Markets are fully pricing in a 25-basis-point reduction, marking the restart of an easing cycle paused since December. Futures also reflect expectations for about 150 basis points in total cuts over the next year. A Fed outlook that aligns with that trajectory would reinforce optimism among equity bulls, who are counting on a gradual easing path to sustain growth and avoid recession.

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“The interplay between inflation and economic momentum through the rest of this year and into next will be central to how far the Fed goes and how the stock market performs,” said Andrew Almeida, director of investments at XY Planning Network.

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If history is any guide, the Fed’s pace of rate cuts could also influence sector performance. Research by Ned Davis shows that when the central bank delivered only one or two cuts after a pause, the economy tended to stay strong, with cyclical sectors like financials and industrials outperforming.

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By contrast, in cycles requiring four or more cuts, growth was usually weaker, and defensive plays like health care and consumer staples posted the best returns.

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“This market really depends on three things: the Fed’s cutting pace, the durability of the AI trade, and whether tariffs fuel another bout of inflation,” said Stuart Katz, chief investment officer at Robertson Stephens.

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Katz pointed to an unexpected dip in producer prices in August as a sign that sticky inflation may not prevent deeper cuts. He has been increasing exposure to small-cap stocks, which often carry more debt and stand to benefit disproportionately from cheaper borrowing. So far this year, the Russell 2000 is up about 7.5%, compared with nearly 12% for the S&P 500.

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Others are taking a different tack. Powell’s comments last month, suggesting that inflationary effects from trade tensions would be “short-lived” and represent a “one-time” adjustment, encouraged some to look beyond small caps. Almeida favors mid-cap stocks, which have historically outperformed both large- and small-cap peers in the year after rate cuts begin. He’s also adding exposure to financials and industrials, sectors that stand to gain from falling rates.

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Balafas, meanwhile, continues to hold positions in megacaps like Nvidia, Amazon, and Alphabet, betting that corporate earnings growth will remain resilient even if the economy slows moderately.

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Still, a sharper-than-expected downturn could force investors to pivot toward defensive sectors. Ned Davis data shows that health care and consumer staples have delivered average returns of roughly 20% during cycles where the Fed was forced into deeper cuts.

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“If growth slows modestly, rate cuts will help,” Katz cautioned. “But if the slowdown turns into a stall, recession risks become much higher. The real question is how comfortable investors are with the economy cooling and we’ll only know that with time.”

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