The past four years have been nothing short of a wild ride for Wall Street. Since this decade began, the iconic Dow Jones Industrial Average (^DJI 0.40%), benchmark S&P 500 (^GSPC 1.02%), and growth-fueled Nasdaq Composite (^IXIC 2.02%), have bounced back and forth between bear and bull markets in successive years.

Currently, the Dow, S&P 500, and Nasdaq Composite are enjoying a major rally off of their 2022 bear market lows. While some investors have been quick to label 2023 as the start of a new bull market, one key event may swing the pendulum in favor of the bears, once again, in 2024.

A person drawing a circle and arrow to the bottom of a steep decline in a stock chart.

Image source: Getty Images.

This event has been a harbinger of bad news for Wall Street since this century began

Let me preface this discussion by noting that there is no such thing as a foolproof predictive indicator or economic datapoint that can forecast the future. If Wall Street offered a certainty, you can rest assured that every professional and retail investor would be exploiting it by now.

There are, however, a handful of metrics and tools that have exceptionally strong correlations with directional moves in the stock market. One of them just happens to be Federal Reserve monetary policy.

The Federal Reserve's job is to sustain economic growth and keep the unemployment rate low, which is accomplished through changes in monetary policy. Monetary policy involves altering the U.S. money supply, which can have positive or negative effects on the U.S. economy.

The most-common way the nation's central bank influences money supply is by adjusting the federal funds rate. Changes in the fed funds rate ultimately result in movements in interest rates, which can impact corporate and consumer borrowing.

Since March 2022, the Fed has been undertaking a tightening cycle. This is to say that it's been raising the federal funds rate, and thus interest rates, to slow down the prevailing inflation rate and to keep the U.S. economy from overheating. Think of it as depressing the brake pedal on a fast-moving car.

The flipside of this is rate-easing cycles, which involves the nation's central bank lowering the federal funds rates (and interest rates) to encourage borrowing. It's akin to depressing the accelerator on a car.

From a psychological standpoint, rate-hiking cycles are viewed negatively by Wall Street and investors. Since raising interest rates makes borrowing costlier, the expectation would be that hiring, innovation, and overall economic growth would suffer. Likewise, lowering interest rates is typically viewed as favorable for businesses, and is something that investors usually look forward to.

To this I say, "Be careful what you wish for."

Effective Federal Funds Rate Chart

Effective Federal Funds Rate data by YCharts.

Although Federal Reserve monetary policy is a mix of history, economics, and gut feeling, the nation's central bank doesn't act without reason. Looking back multiple decades, the Fed initiates rate-easing cycles when the U.S. economy struggles or something breaks, such as we saw during the financial crisis in 2007-2009. When the Fed begins cutting rates, it historically means trouble lies ahead.

Since this century began, there have been three rate-easing cycles (date below represents start of rate-easing cycle):

  • Jan. 3, 2001: The nation's central bank slashed the federal funds rate from 6.5% to 1.75% in under a year when the dot-com bubble burst. The broad-based S&P 500 took 645 calendar days to find its bottom following this initial rate reduction.
  • Sept. 18, 2007: The Fed cut the federal funds rate from 5.25% to a range of 0% to 0.25% during the Great Recession. The widely followed S&P 500 took 543 calendar days to reach its nadir after this initial rate cut.
  • July 31, 2019: The third rate-easing cycle began in July 2019 and saw the fed funds rate decline from a peak range of 2% to 2.25% to 0% to 0.25%. The S&P 500 bottomed out during the COVID-19 crash in March 2020, some 236 calendar days later.

Since this century began, it's taken an average of 473 calendar days (about 15.5 months) for the S&P 500 to reach its bottom once the Fed begins cutting interest rates. More importantly, bear markets followed or were associated with all three rate-easing cycles.

What's noteworthy is that interest rate futures are pricing in approximately 125-basis-points' worth of cuts in 2024. This would suggest the Federal Open Market Committee could reduce rates in four or five of its eight meetings next year.

Although there have been instances where stocks performed very well during rate-easing cycles, we have to go back to the previous century to find them. In other words, Fed rate cuts may signal the start of the 2024 bear market -- at least if history rhymes, once more.

A businessperson critically reading a financial newspaper.

Image source: Getty Images.

History strongly favors the optimistic and patient

A handful of money-based metrics also concur that 2024 could be a difficult year for stocks and the U.S. economy. However, patience and optimism have proved to be insurmountable allies for investors willing to use them to their advantage.

As much as investors might dislike downturns and recessions, they're a perfectly normal aspect of the economic cycle. But the key point about economic weakness is that it's typically short-lived. In the 78 years since World War II ended, there have been a dozen recessions. Just three of these 12 recessions lasted at least 12 months, and none have surpassed 18 months.

Now compare that to periods of expansion. Though there have been a couple of short expansions, most growth spurts last for multiple years. In fact, two economic expansions since the end of World War II endured for at least a decade. Corporate earnings are going to grow in tandem with the U.S. economy over long periods.

Here's what interesting for investors: This long-winded optimism also translates to Wall Street.

Six months ago, investment analysis company Bespoke Investment Group released a dataset that examined the average length of bull and bear markets in the S&P 500 dating back to the start of the Great Depression in Sept. 1929. All told, Bespoke looked at 27 separate bull and bear markets.

What the dataset revealed was that the average bear market lasted just 286 calendar days, or about 9.5 months. By comparison, the typical bull market over the past 94 years has lasted for 1,011 calendar days, or 3.5 times as long as the average bear market.

However, the true value of patience can be seen in a dataset updated annually by the analysts at Crestmont Research. Crestmont's data examines the rolling 20-year total returns, including dividends, of the S&P 500. Even though the S&P didn't come into existence until 1923, its components could be found in other major indexes prior to this time. This allowed Crestmont to back-test its dataset to 1900, leaving 104 rolling 20-year periods (1919-2022) to analyze.

What Crestmont was able to show is that all 104 rolling 20-year timelines produced a positive total return. This is to say that regardless of when an investor, hypothetically, purchased the S&P 500 (or in this case a tracking index), they'd have made money as long as they held that position for 20 years.

Furthermore, holding an S&P 500 tracking index often made people a lot of money. Whereas you can count on one hand how many rolling 20-year periods led to an annualized return of between 3% and 5%, over 50 of the 104 rolling 20-year periods produced annualized returns ranging from 9% and 17.1%.

Though we can't control Federal Reserve monetary policy, we do have a say in how we, as investors, respond to it. Being optimistic and thinking long-term has, for more than a century, been a winning strategy.