Retail investors are bullish on stocks ahead of the Fed's rate cut next month

By Gordon Gottsegen

People are optimistic about the effect rate cuts will have on markets - and hope that cuts signal receding inflation.

August has been an especially volatile month for the stock market, between the steep selloff that happened in the beginning of the month and the bounce back that came shortly thereafter.

Despite that volatility, retail investors didn't budge much. In fact, many piled into equities by buying the dip.

One reason for this, according to Derek Horstmeyer, a professor of finance at George Mason University, is due to the optimism surrounding coming rate cuts.

"Retail investors are holding steady through these turbulent market times primarily due to the Fed's expectations of a rate cut in September," Horstmeyer wrote in a note. "They know that if the Fed cuts interest rates a quarter or half point in a month then this will juice the equity market and retail investors are holding out until that happens."

In a speech at the Jackson Hole Economic Symposium last week, Federal Reserve Chair Jerome Powell said that "the time has come for policy to adjust." This has led many to believe that the Fed will begin its rate cutting cycle during its next meeting in mid-September. Many retail investors fall into this camp.

"We can see it in the actual fed funds futures," Horstmeyer told MarketWatch. "People are betting on pretty aggressive rate cuts to come over the next four to six months. Maybe 75 basis points or all the way up to a full percentage point lower by January."

On top of that, Horstmeyer pointed out that retail investors haven't been moving out of equities - implying that they're still bullish about the future.

Read more: Will stocks rally or fade after the Fed cuts rates? Here's what history tells us.

In addition to what rate cuts might do for the market, people are also hopeful about what rate cuts could mean - that the Fed is confident that it has control over inflation.

"Even though the Fed is saying inflation's behind us, I think until we see true evidence of a soft landing people are still going to be paying attention to the Fed," Horstmeyer told MarketWatch. He added that markets have been reacting strongly to any new piece of data that provides context for the state of the economy, whether that's unemployment data or consumer spending, because it may influence the Fed's policy.

"So for those reasons I still think retail investors - and investors in general - are just really sensitive to what Jerome Powell is doing."

Stephen Callahan, a trading behavior analyst at online brokerage Firstrade, said the anticipation of rate cuts has caused some retail investors to tread carefully.

"Retail investors are increasingly cautious as they anticipate potential Fed rate cuts," Callahan told MarketWatch via email. "Despite positive macroeconomic indicators, the lingering effects of inflation have created uncertainty, with many feeling the economy isn't performing as well as data suggests. This disconnect fuels cautious trading behavior, as investors weigh the risks of inflation eroding their purchasing power."

Callahan brought up that the rate cuts don't just affect the stock market, but also send ripples throughout the broader economy. Consumers could be relieved to see the interest rates on credit-card debt or new mortgages go down.

However, Horstmeyer urged people to keep in mind that even if the Fed cuts rates, it's unlikely that they go back to where they were before the rate hikes.

"Don't expect things to be as rosy in terms of the low interest rates that we saw three years ago," he said. "If you're expecting rock-bottom rates, you're not going to get them. Don't expect to refinance your mortgage at 3%."

-Gordon Gottsegen

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08-29-24 0700ET

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