Wall Street's Bubble May Have Evaporated But Stocks Can Still Sink

The good news for equities is that after this year's sell-off, they no longer appear exorbitantly priced. The bad news is that if corporate profits collapse, none of this will matter. The price of a stock rises or falls for two main reasons: how much cash a company makes and how much an investor is ready to pay for it.

Photo Insert: The concern for Wall Street in the future is that, while most of the air has escaped from the bubble, more could still escape.

So far, Wall Street has concentrated solely on the second portion, Stan Choe reported for the Associated Press (AP) late on June 23, 2022.

With the Federal Reserve raising interest rates to combat inflation, investors are less inclined to pay exorbitant prices for equities when safe bonds provide higher returns. Analysts and professional investors use the price-earnings ratio to assess investors' appetite to hold stocks.

With a few adjustments, it displays how much investors pay for each $1 of a company's earnings.

According to Scott Opsal, director of research and equities at Leuthold, investors are paying about 29 percent less for the median across the largest 1,000 firms than in November. That meant that their stock price decline, which averaged around 25%, was completely due to investors' diminished willingness to pay high prices.

Profit projections were actually raised by analysts. “Investors are coping with the problems of the day by letting the air out of bubbly valuations,” Opsal wrote in a report.

According to Credit Suisse strategists, some parts of the market, such as high-growth and smaller firms, remain expensive. However, throughout the S&P 500 index, stock prices are currently only modestly over their 50-year average, after previously surging to their most expensive levels since the dot-com boom of 2000.

The concern for Wall Street in the future is that, while most of the air has escaped from the bubble, more could still escape. Another risky scenario is a dramatic decline in business profitability. If this occurs, investors may be slammed with a double whammy, pulling down both stock price levers.

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