The Stock Market Finally Had a Winning Week. Why It Might Not Last.

“Stocks finally enjoyed a strong bounce this week,” writes Canaccord Genuity analyst Martin Roberge. “Simply said, just like a rubber band that was stretched too much, pessimism forces are being worked off, hence the snapback rally.”

It’s also simply exhaustion. Stocks can’t fall forever, even if it sometimes feels like they will. And the market gave investors enough reasons to at least relax. It started with

JPMorgan Chase
’s
(ticker: JPM) investor day—one that was far more upbeat than you’d expect, given all the recent recession fears—and ended with a moderated rise in the core personal consumption expenditure index that suggested, perhaps, that inflation had peaked.

But those were all sideshows compared with the real narrative changer—the release of the minutes from the May Federal Open Market Committee meeting on Wednesday. The Federal Reserve committed itself to half-point rate increases in June and July, but left open the possibility of smaller hikes—or none at all—from there. By the end of the week, the chances that the federal-funds rate would hit 3% by the end of the year had dropped to 35%, down from 60% the week before. A less-aggressive Fed is exactly what the stock market has been looking for.

But is it enough? Deutsche Bank strategist Alan Ruskin says investors have to decide if the 10-year Treasury yield at 2.75% and the S&P 500 near current levels are enough to get inflation heading back toward 2%. “If the answer is YES (presumably supply improvements dominate any push toward lower inflation), then risky assets are secure,” Ruskin writes. “If the answer is NO, then the Fed will have to do more heavy lifting in raising [short term] rates over and above what is priced, driving a greater tightening in financial conditions. In case you had not guessed, my personal view is: NO.”

And even some of the bulls acknowledge that the risks have risen, even with the stock market rally. Yardeni Research’s Ed Yardeni notes that the Fed’s focus on inflation has caused the market’s latest panic attack. “But this one won’t end until inflation moderates significantly all by itself or with the help of a Fed-induced recession, either by design or by accident,” he writes. “We think that can happen without a recession. Nevertheless, we now are raising the odds of a recession from 30% to 40%.”

What’s the best play when the economy—and the stock market—can go either way? It’s not the formerly highflying speculative-growth stocks that have been hit so hard this year, which demonstrated this past week that they could still fall further even after dropping 50% or more.

Snowflake

(SNOW) fell 4.4% on Thursday after reporting earnings that showed signs of slowing demand from some of its clients, while lockdown favorite

Workday

(WDAY) dropped 5.6% on Friday after its earnings came in short of analyst forecasts.

Snap
’s
(SNAP) earnings were so bad, the stock not only dropped 43% this past 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 steady earnings, positive free cash flow, and a track record of managing through the economic cycle. “Instead of trying to figure out if it’s a hard landing or soft landing, maybe it’s best to protect on the downside,” says Vontobel Asset Management’s David Souccar. “This is the time to be thinking about capital protection.”

Especially now that the market finally has that winning spirit again.

Write to Ben Levisohn at Ben.Levisohn@barrons.com