This Stock Market Indicator Has Been 83% Accurate Since 1984. It's Signaling a Big Move in the S&P 500 Right Now.

Inflation hammered the U.S. economy following the pandemic. Business closures led to supply chain disruptions, which evolved into an imbalance between supply and demand as the government issued trillions of dollars in stimulus payments. Simply put, too much money was chasing too few goods, something famed economist Milton Friedman once said was a recipe for inflation.

Indeed, that mismatch drove consumer prices higher at a pace not seen in decades, forcing the Federal Reserve to respond in equal measure. Policymakers raised the federal funds rate -- a benchmark interest rate that influences other rates throughout the economy -- at its fastest pace since the early 1980s. By increasing the cost of borrowing, policymakers hoped to curb spending and cool inflation.

Yet the aggressive nature of those rate hikes worried Wall Street -- so much so that the S&P 500 (^GSPC 1.02%) slipped more than 19% last year, its worst annual decline since the Great Recession in 2008. But the index has rebounded sharply this year amid signs of economic resilience. Gross domestic product increased at a 5.2% rate in the third quarter, meaning the economy expanded more than twice as fast as the 20-year average.

Meanwhile, inflation has cooled substantially from its peak of 9.1% in June 2022, falling to 3.1% in November 2023. Policymakers seem satisfied with that progress. Recent commentary from Fed Chair Jerome Powell hints at an end to the rate-hike cycle, and such a shift in monetary policy historically bodes well for the stock market.

History says the S&P 500 could move much higher in 2024

The Federal Open Market Committee left the target federal funds rate unchanged at 5.25% to 5.5% at its December meeting. However, updated projections from policymakers point to three 25-basis-point rate cuts next year, and seven 25-basis-point rate cuts by the end of 2025.

The market expects credit conditions to loosen even faster. CME Group's FedWatch Tool, which measures the odds of future rates using pricing data from federal funds futures contracts, currently implies a 100% chance that the current rate hike cycle is over, and a 91% chance that the Federal Reserve will cut rates by at least 100 basis points next year.

Either way, the transition from rate hikes to rate cuts could act as an accelerant on the economy, which itself could bolster corporate revenue and earnings growth, driving the stock market higher. Historical data supports that assumption.

The Federal Reserve has steered the economy through six rate hike cycles since 1984, and the S&P 500 increased five times (83% of the time) during the 12-month period following the end of those cycles. Additionally, the index returned an average of 15.9% during the 12-month period following the last hike in each cycle, as shown in the chart.

Data source: Federal Reserve Bank of St. Louis, YCharts.

Let me be clear: Past performance is never a promise of future returns, and investors should avoid strategies based on market timing. Every rate hike cycle shown in the chart was brought on by unique circumstances, and none of them involved a global pandemic. So the aftermath of the current rate hike cycle could be different.

That said, history points to upward momentum in the S&P 500. For context, the Federal Reserve last raised its benchmark interest rate on July 27, and the S&P 500 has increased 4% since then. That means the implied upside is about 12% over the next 12 months, assuming policymakers have truly reached the end of the current rate hike cycle.

Investors should prioritize long-term returns

Investors looking to benefit from potential upward momentum in the S&P 500 have several options. Many good stocks look attractive at their current valuations. But purchasing an S&P 500 index fund like the Vanguard S&P 500 ETF (VOO 1.00%) is the most obvious and easiest way to benefit.

In either case, investors must have the right mindset. That means a buy-and-hold strategy that prioritizes long-term returns.

The importance of a long-term mindset cannot be overstated. While history implies an 83% chance the S&P 500 will increase through July 2024, that leaves a 17% chance the index will decline. Moreover, both figures are based on data pulled from a relatively limited number of events. As outlined in the chart, the Federal Reserve has only engaged in six rate hike campaigns before the current one.

To that end, investors should benchmark their prospective returns against a broader dataset. For instance, the S&P 500 has never failed to increase during any rolling 20-year period in history, so patient investors who buy an S&P 500 index fund today can confidently assume they will turn a profit over the next 20 years.

Additionally, the S&P 500 returned 1,700% over the last three decades, or 10.1% annually. If all goes well, patient investors who buy an S&P 500 index fund today can reasonably hope to see a similar rate of return over coming decades.