Mark Hulbert: Why even the best analysts can’t predict the next bear market for stocks

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Grizzly and Wolf Discovery Center

You’re kidding yourself if you think a bear market won’t happen so long as a recession is not on the horizon.

That’s the conclusion I draw from a provocative — and depressing — recent study by Vincent Deluard, head of global macro strategy at INTL FCStone, a financial services firm. He found that you could still lag the U.S. market even if you had perfect insight into future U.S. GDP growth.

For starters, consider how well you would do if you knew one quarter in advance what the final GDP number would be. That is already asking a lot, of course, since that number doesn’t become final until a number of subsequent revisions by the U.S. government’s Bureau of Economic Analysis. Unfortunately, other than allowing you to earn bragging rights in Wall Street’s forecasting sweepstakes, this knowledge would do you surprisingly little good.

To show how little, Deluard constructed a hypothetical portfolio that was 100% invested in the S&P 500 SPX, -0.10%   whenever the next quarter’s GDP growth was higher than in the current quarter, and otherwise 100% in cash. Believe it or not, as you can see from the accompanying chart, this portfolio trailed a buy-and-hold strategy by one percentage point annualized since 1948.

Consider next what your performance would be with even greater foresight: Suppose you were able to predict the final GDP number four quarters in advance. When translating that prescience into an all-stock or all-cash portfolio, Deluard found that it did better — but only somewhat. While it beat a buy-and-hold, it did so modestly — by less than one annualized percentage point. And it still did less well than a simple strategy that used the 200-day moving average to switch between stocks and cash. (See chart, below.)

Why is foresight worth so little? Deluard says that it’s because profit margins and P/E multiples are more important than economic growth to the stock market’s bull-and-bear-market cycle. He reminds us that the market’s level can be calculated by multiplying Sales by Profit Margin and P/E Multiple. “Economic growth [i.e. sales] only matters for a fraction of one term” in this equation, Deluard points out, since “about half of the revenues of the S&P 500 index companies come from abroad.”

The investment implication is that analysts “should spend less time worrying about the next recession and focus on the two second terms of the equation — margins and multiples.”

That’s a sobering implication, since both margins and multiples currently are close to historic highs. If either of them revert to their historical means, the stock market will plunge — even if there is no recession.

So what the bulls really should be hoping for is not the absence of a recession but that margins and multiples stay sky high!

For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com .