Magnificent Seven: Undampened by Rate Cuts

On the 18th of September, the U.S. Federal Reserve System (or “Fed”) slashed interest rates for the first time since March 2020. The decision wasn’t a unanimous one among the Governors; nonetheless, it was a supersized one at 50 basis points. While Federal Reserve Chair Jerome Powell stated that such a decision was made to keep the US economy in its current “good shape”, the reality is that that both consumers and businesses in the U.S. have been reeling from high borrowing costs. While the cut delivers some benefits to them, it is not a given that economic risks have diminished.

Since 1990 and excluding the rate cuts made during the pandemic, the Fed has had six rate cut cycles. On average, the economy has fallen into a recession 18 months from the point that the Fed began cutting rates. But this average is derived from a wide range: after the Fed began cutting rates in July 1995, recession occurred a full 69 months later. On the other hand, a recession was declared immediately after Fed cut rates in July 1990 and two months after cuts began in January 2001.

The unemployment rate is a key indicator on whether the U.S. is in a recession and there are several critics of the means of calculating this. Nonetheless, even by the Fed’s own accepted means of calculation, the unemployment rate rose by 1.4% on average across all six cycles. Here too are a number of variances: a year after the rate cuts started in July 1995, the unemployment rate remained unchanged. On the other hand, the unemployment rate was actually lower from the previous year when the Fed initiated rate cuts in September 1999. In the other four cycles, unemployment rate rose by at least 1% a year afterwards.

All in all: at least since the nineties, the Fed’s rate cut cycle emerges more often as the means to soften the blow for consumers and businesses while recession is underway and provide the means for them to rebuild afterwards. As a means of preventing recession or indicating that a recession won’t happen, it has consistently failed.

The size of the rate cuts in itself wasn’t much of a surprise to markets: as of the Sunday preceding the rate cut announcement, a majority of traders focused on U.S. markets had estimated it.

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Source: CME FedWatch

The Magnificent Seven – comprising of Alphabet (or “Google”), Apple, Microsoft, Tesla, Amazon, Meta Platforms (or “Facebook”) and NVIDIA – had largely been on a tear for several quarters preceding the rate cut announcement. On the day of the rate cut announcement, however, some of the Magnificent Seven (notably: NVIDIA) did show signs of weakness while the rest of the broad-market S&P 500 showed some signs of recovery:

Source: FinViz

By the end of the week, however, it emerged that – within the S&P 500 – energy, financials and certain tech names dominated positive trajectories.

Source: StockTwits

When considering the Magnificent Seven on average (in equally-weighted terms on a daily basis rather than market capitalization), conviction more or less held out and even strengthened after the rate cut announcement.

Source: Leverage Shares analysis

Relative to 3rd September and as of the 23rd of September, the Magnificent Seven (on average) rose with around a 4% premium over even the “tech-heavy” Nasdaq-100 and a 5% premium over the broad market.

In fact, the bulk of a positive uptrend in their trajectories have yielded professional investors in Europe a strong possibility in making tactical gains via the 5x Magnificent Seven ETP (MAG7) which is primed to collect outsized returns on an uptrend:

Source: Leverage Shares analysis

Across September till the 23rd, it has delivered over 31% in performance, i.e. nearly 7 times what holding the Nasaq-100 would have delivered.

Regardless of NVIDIA’s performance – which is largely informed by uncertainty of recent growth being maintained as AI spending is expected to either draw down or diversify away from being driven by the company’s products – the Magnificent Seven has positioned themselves in U.S. market investors’ collective consideration as being the cornerstone of the U.S. market and also generally expected to be the most “survivable” companies outside of energy firms and major financial institutions. The recovery trends overall across the Magnificent Seven doubles down on the expectation that recessionary concerns haven’t significantly dissipated and that market breadth isn’t expected to increase.

Professional investors in Europe can consider a number of scenario-driven tactical plays to boost portfolio gains as uncertainty looms. For instance, in the event that the bulk of investor conviction rotates out of the Magnificent Seven and into either the bulk of the S&P 500 or Nasdaq-100, holding the “-3x Short Magnificent 7 ETP” (MAGS) as well as the +5x Long S&P 500 ETP (SP5Y) or the +5x Long Nasdaq 100 ETP (QQQ5) could deliver strong benefits during the shift of convictions out of the Magnificent Seven. In the event that the inverse happens, MAG7 along with the -5x Short S&P 500 ETP (SP5Y) or the -5x Short Nasdaq 100 ETP (QQ3S) could.

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