Profit ratio

Wall Street’s bubble may be gone, but stocks can still fall | News, Sports, Jobs

A trader works on the floor of the New York Stock Exchange in New York. Photo of the AP file

NEW YORK — The good news for stocks is that this year’s sell-off means they no longer look overpriced.

The bad news: It won’t matter if corporate earnings falter.

The price of a stock goes up or down for two main reasons: how much cash a company generates and how much an investor is willing to pay for it.

So far, Wall Street has focused only on this second part.

With the Federal Reserve raising interest rates to drive down inflation, investors are much less willing to pay exorbitant prices for stocks when safe bonds offer better yields.

Analysts and professional investors look at what is called the price-to-earnings ratio to gauge investors’ willingness to own stocks. It shows how much investors pay for every dollar of a company’s earnings, with some variations.

Among the 1,000 largest companies, one metric has investors paying nearly 29% less for the median than in November, according to Scott Opsal, director of research and equities at Leuthold.

This meant that their fall in share prices, a median of around 25%, was entirely due to investors’ diminished willingness to pay high prices. On the earnings side, analysts have actually raised their forecasts.

“Investors deal with the issues of the day by letting the air out of bubbly valuations,” Opsal wrote in a report.

According to Credit Suisse strategists, some pockets of the market still look expensive, such as high-growth stocks and small stocks. But across the S&P 500 index, stock market valuations are now only slightly above their 50-year average, having hit their most expensive levels since the dot-com mania of 2000.

The risk for Wall Street going forward is that while a lot of air has come out of the bubble, more could still escape. Another dangerous possibility is if corporate earnings weaken sharply.

If that were to happen, investors could take a double whammy by lowering both stock price levers.

As inflation apparently continues to accelerate, this risk is growing. Several major retailers, including Target, have recently warned of shifting shopping behavior among their customers as the pandemic subsides. Meanwhile, all businesses face higher costs for fuel as gasoline prices soar and for labor as workers demand higher wages in a tougher market. booming job.

Companies must soon declare the profits they made in the spring. Analysts forecast weakened growth at the slowest pace since the end of 2020, according to FactSet.

Some critics say these forecasts are still too optimistic. If the earnings forecast drops, it would trigger another drop in stocks.

Copyright 2022 The Associated Press.

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