Don’t Fight the Fed: Why a Multi-Year Rate Cut Cycle Could Power a Durable Bull Market

Author: Montecito Capital Management

When the Federal Reserve shifts from tightening to cutting, markets tend to respond in patterns that echo across decades. But each cycle has its own character — shaped by inflation trends, liquidity conditions, earnings resilience, valuations, and investor psychology. The current environment is no different. With inflation easing, employment holding firm, quantitative easing long behind us, and earnings continuing to surprise the upside, the setup heading into a multi-cut cycle looks materially different from several of the prior downturn-driven regimes.

This is not a standard “rescue” cycle — it’s more measured, with a solid economic foundation supporting the potential for sustained gains. It helps to look not only at the narrative, but at the data. Historically, the S&P 500 finishes positive in roughly two-thirds to three-quarters of Fed easing cycles. But the magnitude of those gains — and the path markets take to get there — varies widely depending on the macro backdrop. Cycles associated with recession tend to have volatile starts and muted cumulative returns; cycles associated with stabilization or pre-emptive “insurance cuts” tend to produce firmer, faster rebounds.

Today’s environment shows several encouraging distinctions:

• The unemployment rate remains low by historical standards, even after recent softening.
• FactSet data shows S&P 500 earnings continue to come in ahead of expectations, with positive earnings-surprise rates still near long-term averages.

• Year-to-date average: Approximately 81% of S&P 500 companies have reported positive EPS surprises in 2025 (weighted across completed quarters). This is notably higher than the 10-year historical average of 75%, signaling better-than-expected corporate performance amid economic resilience.

• The post-pandemic liquidity wave has long normalized; quantitative easing ended years ago, removing distortions that complicated earlier cycles.
• Sector leadership is broadening beyond the mega-cap complex — a sign markets are adjusting to a more durable rate environment.

Cumulative Performance During Past Easing Cycles

Looking at the full set of easing cycles since the 1970s, the S&P 500’s average cumulative gain is +30.3%, while the median sits at +13.0%. But the numbers alone don’t tell the full story — the human experience within each cycle matters.

Rebound-driven cycles tend to be quick and concentrated in leadership sectors; recession-linked cycles are slower and more uneven. Investors may remember the 1995–1999 cycle as a smooth runway of compounding, but even during that expansion there were periods of doubt and volatility. Likewise, the 2019–2021 easing period produced strong overall performance despite extreme swings during the pandemic shock.

Cumulative returns show what happened in total. They don’t show the tempo at which investors lived through it. Looking at historical cycles, it’s clear that markets tend to reward patience, especially when easing occurs outside of a recession.

Annualizing the Returns: Understanding Pace, Not Just Totals

Cumulative figures are helpful, but they obscure an essential point: easing cycles vary dramatically in length. That’s why translating cumulative returns into annualized returns gives a better sense of how quickly markets advanced during each period.

To do this, I used the actual length of each cycle — from the first rate cut to the final cut, or to the first hike when the Fed reversed quickly. Some cycles lasted only about four months (1998), while others stretched close to three years (2001–2003 and 2020–2022). As a result, a +20% cumulative gain could reflect a sharp, sentiment-driven rebound over a few quarters, or a slow grind over many.

Across nine easing cycles since the 1970s, the normalized results look like this:

Investor takeaway: Annualized returns help investors understand how quickly gains were realized, providing insight into the pacing of past cycles. Shorter, pre-emptive cycles often reward quick, decisive positioning, while longer cycles reward steady exposure.

Probability of Positive Returns at Key Horizons

History also shows how quickly returns materialize once cuts begin:

Investor takeaway: Month 15–16 historically represents a sweet spot for equity performance — roughly three out of four cycles are positive, offering a high-probability window for gains.

Scenario Forecast Through Late 2026

Looking ahead, probability-weighted scenarios help frame realistic expectations:

Investor takeaway: The distribution favors positive outcomes, but investors should remain mindful of cyclical risks and maintain diversified portfolios.

Why This Cycle Looks Different

Today’s setup differs in several meaningful ways from prior fragile easing cycles:

• Inflation is decelerating in a controlled manner, not collapsing due to demand destruction.
• Employment is slowing but still healthy, supporting consumption.
• Corporate earnings continue to surprise to the upside, providing fundamental justification for equity strength.
• Valuations remain elevated but not extreme, creating space for re-rating.
• Market concentration is slowly easing, with more sectors participating in new highs.

Investor takeaway: The current cycle is less reactive and more structurally sound — a setup that historically rewards patient investors.

Risks and the Case for Portfolio Protection

No cycle is without risk!

• Elevated valuations at the index level: Elevated valuations at the index level, with the S&P 500 trading near 23–24× forward earnings (about 25–30% above its 10-year average), are partly offset by robust earnings strength, where upside surprises continue to run above long-term norms.
• Politicalizing the Federal Reserve with a patsy new Fed Chair: Markets are built on the assumption that the Fed is independent and focused on price stability, not politics.
• Heavy concentration in mega-cap tech: On concentration, just eight mega-cap stocks now comprise roughly 34 % of the S&P 500’s total market-cap weighting.
• Geopolitical instability: Whether it’s the Middle East, Ukraine, or increasing tension with China, the risk isn’t a single headline—it’s escalation.
• Lags in the real economy from prior tightening: Lags in the real economy from prior tightening continue to filter through, as higher borrowing costs, slowing credit creation, and decelerating consumer demand typically take 6–18 months to fully impact growth.
• Sticky inflation risk: Sticky inflation remains a risk — with the Consumer Price Index still above 3% annually and services, wages, and housing-related costs continuing to run hot — and further compounded by tariff pressure on prices as higher import costs get passed through to consumers.
• Fed policy mistakes are more dangerous late in the cycle: Fed policy mistakes are more dangerous late in the cycle, as delayed adjustments can amplify economic slowdowns, trigger sharper market volatility, and leave limited room to respond if growth or inflation surprises.
• Potential consumer fatigue: Consumer spending which accounts for roughly two‑thirds of U.S. GDP may be vulnerable if household savings rates continue to slip from the recent ~8 % range and real wage growth fails to keep up with inflation, increasing the risk of demand softness.

Investor takeaway: Preparation is key — portfolios should be designed to weather volatility while remaining positioned for upside.

How Montecito Capital Management Helps Clients Navigate Cutting Cycles

A constructive market backdrop doesn’t eliminate uncertainty — it simply increases the importance of building portfolios that can endure both smooth and turbulent periods. At Montecito Capital Management, our focus is on helping clients pursue financially secure futures through a disciplined, goal-driven framework centered on liquidity, sustained growth, income reliability, and risk containment.

We begin with the client’s objectives, resources, and constraints, then design a portfolio architecture that aligns each investment with a clear purpose. Because understanding embedded risks is essential to long-term success, we construct and actively manage diverse, multi-asset portfolios built to participate in long-term positive returns while maintaining resilience during periods of market stress.

Our investment philosophy emphasizes broad diversification across economically representative asset classes, with risk exposure adjusted according to forward-looking assessments of economic trends, valuation conditions, and fiscal-monetary policy. We allocate across distinct categories of liquid investments — each serving a specific role:

1. Longer-term return drivers — equities and growth-oriented assets designed to capture the compounding power of innovation, productivity, and corporate earnings expansion.
2. Shorter-term risk reducers — high-quality fixed income, cash equivalents, and defensive exposures that help stabilize portfolios during periods of stress.
3. Hybrid exposures — strategies that blend return potential with defensive characteristics, including hedged equity, structured notes with buffers, and selective income instruments.
4. Diversifying liquid (tradeable) alternatives and absolute-return strategies — assets and strategies that behave differently from traditional stock-bond allocations, such as managed futures, market-neutral approaches, real assets, global macro, long-short, and other non-correlated sources of return.

Investor takeaway: Each allocation plays a purposeful role, helping portfolios participate in growth while cushioning against risk.

Conclusion

History shows that Fed easing cycles often create strong opportunities for equities — particularly when cuts occur outside of a recession. The current cycle is distinctive: inflation is easing, employment is healthy, corporate earnings are resilient, and valuations remain reasonable. These factors combine to create a favorable environment for sustained equity gains over the next 12–24 months.

Here’s what investors should remember:

1. Timing matters, but so does patience. Month 15–16 of a rate-cut cycle has historically been a sweet spot, with roughly 75–80% of cycles showing positive returns.
2. Earnings and fundamentals drive durable gains. Strong corporate performance and steady consumption underpin market resilience, not just lower rates.
3. Risk management remains essential. Diversified, multi-asset portfolios help navigate volatility, sector concentration, and macro uncertainties.
4. Expect variability, not straight lines. Even constructive cycles include periods of dips and corrections — preparation is what separates outcomes.

5. Key points: Strong fundamentals — healthy jobs, steady earnings, and normalizing liquidity — create a fertile environment for equity growth once cuts begin.

In short, the combination of a constructive macro backdrop, historically favorable patterns, and disciplined portfolio design points to a compelling opportunity set. Investors who remain patient, diversified, and focused on fundamentals are well-positioned to participate in potential gains while managing downside risk.

The weight of historical precedent, combined with today’s macro fundamentals, leans toward a constructive multi-year outcome as the Fed moves through this cutting cycle. But even the most favorable cycles include periods of turbulence. The goal is not to guess every twist but to position portfolios so that volatility becomes manageable rather than destabilizing.

Montecito Capital Management’s philosophy is simple: capture the opportunity, protect the progress, and compound steadily through full cycles. In an environment where policy is shifting, leadership is broadening, and fundamentals still support growth, that discipline matters more than ever.