The next recession could actually be a win for stocks - if you can tune out the market noise

By Mark Hulbert

Corporate profit margins and P/E multiples - not GDP forecasts - are the real tools to surviving a bear market

You're probably worrying too much about a recession.

I say that not because the U.S. economy will avoid recession - I have no idea. One could begin at any time - especially with the Middle East conflict and the skyrocketing oil prices (CL00) (BRN00) to which it has led, coupled with the weak labor market and myriad other factors. Earlier this month, the International Monetary Fund warned of a global recession if the Strait of Hormuz stays closed.

But not all recessions lead to bear markets, and not all bear markets are accompanied by recessions. Rather than obsess about a recession, investors should focus on other factors that historically have a bigger influence on stock prices - such as corporate profit margins and price-to-earnings multiples.

There have been 10 bear markets in the U.S. over the past four decades, according to the bull and bear market calendar maintained by Ned Davis Research. Six of the 10 had no corresponding recession, according to the National Bureau of Economic Research - the unofficial arbiter of when recessions begin and end. (To determine if there was a corresponding recession, I looked to see if any overlapped with a period beginning one year before the bear market's start and ending one year after the bear market's end.)

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GDP clairvoyance is overrated

Could you beat the market by having advance knowledge of each quarter's GDP growth rate?

To show how tenuous the connection is between recessions and bear markets, Vincent Deluard, director of global macro strategy at StoneX, once conducted a fascinating thought experiment: Could you beat the market by having advance knowledge of each quarter's GDP growth rate?

Deluard first assumed that you could know a given quarter's final GDP growth rate one quarter in advance. Since we don't have even a preliminary government estimate of a quarter's growth rate until well after it's over, and since we have to wait even longer for the final number, such advance knowledge would require substantial clairvoyance.

Yet even if you were spot-on with your trading, a passive buy-and-hold stock portfolio still did better than your active one by 1 annualized percentage point between 1948 and 2018, according to Deluard. This assumes you stayed 100% in cash and were fully invested in stocks only when a quarter's GDP growth was higher than in the one before.

Deluard then ran the experiment for an investor who could see even deeper into the future - knowing the final GDP growth rate four quarters, or a full year, in advance. Here, this hypothetical market-timing portfolio did better than a buy-and-hold investor - but by less than 1 annualized percentage point.

Surprising as these results may be, Deluard said they make sense. The stock market's level can be mathematically represented by the product of three variables: a) corporate sales, b) profit margins (i.e., the proportion of sales that makes it to a corporation's bottom line), and c) the price-to-earnings multiple. He pointed out that "the economy only matters for a fraction" of the first variable.

Deluard's conclusion: "Analysts should spend less time worrying about the next recession," and focus instead on margins and multiples.

Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at mark@hulbertratings.com.

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-Mark Hulbert

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05-02-26 1037ET