How interest rate cuts could transform the stock market

The Street

Jim Paulsen, author of Paulsen Perspectives, breaks down why Fed easing could spark a broad market rally.

Transcript

00:00What are some of the value sectors right now? Because we have seen more participation, if you

00:07will, outside of tech. We have industrials higher, utilities higher. So it isn't just a tech rally,

00:14but to your point, it hasn't been as broad-based. So tell us some of the value sectors you found.

00:21Well, the places I would look right now is, I think a key to this is going to be,

00:27the reason we've had such a narrow bull market, I think, is because the Federal Reserve in this

00:32bull market has been tight throughout almost its entire existence. It's eased in three months late

00:39last year. And outside of that, it's been raising rates for being tight with monetary policy throughout

00:44the bull. It's a rarity. If I go back in post-war history, almost all bull markets begin with

00:50monetary easing and have easing going on during a substantial portion of the bull. This one has

00:56lived its entire existence under tightening. I think that's why it's been such a narrow advance.

01:01It's when you have tightening going on, monetary tightening, it kind of wipes out a lot of the

01:07general stock market that needs monetary liquidity, that needs lower interest rates to perform.

01:12And it puts us into the most kind of conservative, not really conservative, but unit growth companies

01:18there are that aren't as dependent upon policy easing to get their earnings. And that is the

01:24quintessential technology and here growth stock, which has been the pinnacle of this bull market.

01:31I think, though, the Fed's getting close to easing. If we can get this tariff thing resolved

01:36before too long, I think the Fed's going to ease into this and will be the first easing really on a

01:42consistent basis of this bull market. And I think that's going to awaken a lot of parts of the stock

01:47market. We haven't seen yet. I think, you know, when we drop rates, you're going to, then the

01:54liquidity or monetary growth rate is going to pick up. And I think the biggest, one of the biggest

01:58beneficiaries is going to be small cap stocks. Overall, I know they've been left for dead and I

02:04even have trouble saying, recommending them because they've been dead for so long. But I do think it's

02:09been tied to Fed policy. And if that changes, I think that's going to change right into the sweeping

02:14spot of small cap stocks. I would also point out just in the last month or so, micro cap stocks have

02:22picked up a fair amount relative to small caps, the Russell 2000. And maybe that's a sign from the

02:28very bottom up that capitalization is starting to awaken a little bit. I'd also point out that we've

02:34had a little better activity and, you know, IPOs and some of that things, which is down on the cap

02:40spectrum as well. So I, there might be some, some good signs going on there because in part the money

02:46supply is starting to rise again. It was negative for so long year on year at a record setting like

02:53the time that is now back positive and still growing. And that could help that sector. I think

02:57there was a lot of values throughout that entire marketplace. I also like international stocks in

03:02general, because we're already seeing if we drop rates and increase the U S money supply in this,

03:10in the slower growing U S economy, that's going to bring the U S dollar down. It's already starting

03:15to occur as the money growth's picked up is concerns about growth slowing a little bit has come down.

03:20You can see the dollar weakening and that's alive in the international stock markets, which really

03:26they're doing about as well as some of the tech sectors here in the United States late with dollar

03:31weakness. I think that's going to continue. The dollar is extraordinarily high. The start of this

03:36year, the real value of the trade way, U S dollar index got to within a couple of percentage points

03:42of its all time record high in March of 1985. And, um, um, you could argue that in the last decade,

03:51the dollar has gone up about 50% in real terms. That's one of our tightest, uh, dollar policies we've

03:56ever employed since the dollar began floating in the early 1970s. And it's killed international

04:03stocks more than anything. If the dollar now is starting to weaken, it could weaken a long ways

04:08just to get back to average. And that could do a lot for international stocks in general. And then

04:13lastly, I think, I think value stocks just in general, um, sort of looking at the perspective of

04:21lower PE's stocks overall, probably more cyclically based, uh, areas of the market,

04:27I think are attractive because I think because of our tight monetary policy overall, um, and because

04:35of our restrictive dollar and because of the chronic inverted yield curve or a flat yield curve that

04:41we've had and chronically, you know, 7% mortgage rate in the economy, which is growing in 2% or less

04:47right now. Um, I think that's just depressed kind of the cyclical value parts of the stock market.

04:53If we do ease now for a period of time on a consistent basis, I think that could pick up a

04:58lot of that cyclical part of the market and some of those deep value plays, you know, it takes

05:02confidence to buy things that have been so out of favor for so long. And, um, one of the things

05:10that is going to be necessary for value stocks to do better is we're going to have to lift consumer and

05:16business confidence in this country. And again, it's not the only thing holding it down, but I

05:21think one of the big things is just a long period of time with monetary tightening going on. And if we

05:27turn to easing, you start lifting the money supply, lowering yields, expand or steep in the yield curve,

05:33I think confidence about the future economy improves. And in that sort of situation, confidence

05:40on Main Street picks up and that's the type of thing needed for investors to look at some beat up,

05:46uh, but really attractively valued parts of the marketplace that people have ignored for a long time.

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