The stock market ended its several-week losing streak, and like a sports team that finally got a win, it’s worth celebrating. It just does not mean that the team – or this stock market – is good.
Still, it was a great relief when the market finally managed to gather a few good days, enough for
Dow Jones Industrial Average
to gain 6.2% for the week, ending an eight-week losing streak. After seven long weeks of decline,
S&P 500 index
increased 6.6%, and
rose 6.9 pct. And that was reason enough for optimism.
“Equities finally enjoyed a strong jump this week,” writes Canaccord Genuity analyst Martin Roberge. “Simply put, just like a rubber band that was stretched too much, the forces of pessimism are processed, hence the snapback rally.”
It is also simply exhaustion. Stocks can not fall forever, even if it sometimes feels like they will. And the market gave investors enough reasons to at least relax. It started with
(ticker: JPM) investor day – a day far more optimistic than you might expect, given all the recent recession fears – and ended with a moderate rise in the core index of private consumption spending, perhaps suggesting that inflation had peaked.
But those were all side shows compared to the real narrative changer – the release of the minutes of the May Federal Open Market Committee meeting on Wednesday. The Federal Reserve committed to a half-point rate hike in June and July, but left the possibility of minor hikes – or none at all – open from there. At the end of the week, the chances that the federal interest rate would hit 3% by the end of the year had fallen to 35%, a fall from 60% the week before. A less aggressive Fed is exactly what the stock market has been looking for.
But is that enough? Deutsche Bank strategist Alan Ruskin says investors need to decide whether the 10-year government interest rate of 2.75% and the S&P 500 near the current level is enough to get inflation heading back towards 2%. “If the answer is YES (presumably supply-side improvements dominate any push toward lower inflation), then risky assets are safe,” Ruskin writes. “If the answer is NO, then the Fed will have to make more heavy lifting in raising [short term] prices in addition to the priced one, which drives a greater tightening of economic conditions. If you had not guessed, my personal position is: NO. ”
And even some of the bulls acknowledge that the risks have increased, even with the stock market rise. Yardeni Research’s Ed Yardeni notes that the Fed’s focus on inflation has caused the market’s recent panic attack. “But this will not end until inflation is moderated substantially entirely by itself or by a Fed-induced recession, either by design or by accident,” he writes. “We think it can happen without a recession. Nevertheless, we are now raising the odds of a recession from 30% to 40%. ”
What is the best bet when the economy – and the stock market – can go both ways? It is not the previously high-flying stocks with speculative growth that have been hit so hard this year that showed in the past week that they could still fall further, even after a fall of 50% or more.
(SNOW) fell 4.4% on Thursday after reporting earnings showing signs of declining demand from some of its customers while lockdown favorite
(WDAY) fell 5.6% on Friday after earnings were short of analysts’ forecasts.
(SNAP) earnings were so poor that the stock not only fell 43% last Tuesday, but also took the Nasdaq Composite down with it.
Instead, investors are best served by avoiding unprofitable companies, especially those with lots of debt, and focusing on those that have stable earnings, positive free cash flow, and a track record of getting through the economic cycle. “Instead of trying to figure out if it’s a hard landing or a soft landing, it might be best to protect on the downside,” says David Souccar of Vontobel Asset Management. “This is time to think about capital protection.”
Especially now that the market finally has that winning spirit again.
Write to Ben Levisohn at Ben.Levisohn@barrons.com