Will the Stock Market Crash in 2026? Understanding the Federal Reserve's Valuation Concerns

The S&P 500 delivered impressive gains for the third consecutive year in 2025, rising 16%. But now, as we head deeper into 2026—a midterm election year—serious questions loom about whether this winning streak will continue. The Federal Reserve has sounded the alarm, warning that equity valuations have reached dangerous levels. Combined with historical patterns suggesting market weakness during election years, investors face genuine uncertainty about what 2026 will bring.

Federal Reserve Chair Jerome Powell made headlines in September by cautioning that stock valuations were “fairly highly valued by many measures.” Since then, the S&P 500 has climbed further, pushing valuations into even more rarefied territory. Fed Governor Lisa Cook reinforced this concern in November, noting an “increased likelihood of outsized asset price declines.” The central bank’s Financial Stability Report highlighted that the S&P 500’s forward price-to-earnings ratio is now “close to the upper end of its historical range.”

Currently, the index trades at 22.2 times forward earnings—a significant premium over the 10-year average of 18.7. This matters because history shows a clear pattern: whenever valuations reached this level, major corrections followed.

A History of Midterm Election Year Market Turbulence

Midterm election years have historically been rough territory for stock market investors. Since the S&P 500’s inception in 1957, it has gone through 17 midterm elections. During those years, the index averaged just 1% in returns (excluding dividends)—a stark contrast to the typical 9% annual average. When a sitting president’s party faces midterms, the picture gets even bleaker. The S&P 500 has declined by an average of 7% when that scenario unfolds.

Why does this happen? Midterm elections introduce significant policy uncertainty. The political party controlling the presidency typically loses Congressional seats, leaving investors unsure about the direction of economic policy. Markets hate uncertainty, and uncertainty causes selloffs.

However, the silver lining is that this uncertainty doesn’t last long. History shows that the six months following midterm elections—from November through April—have been among the strongest periods in any four-year presidential cycle. The S&P 500 has averaged 14% returns during these post-midterm months, suggesting that any weakness early in an election year tends to reverse sharply later on.

The Fed’s Red Flag: Valuations at Historic Highs

The Federal Reserve’s warnings about valuation stretch beyond a few cautious comments. FOMC meeting minutes from October specifically noted that some participants flagged “stretched asset valuations,” with several pointing to “the possibility of a disorderly fall in equity prices.” This language reflects genuine concern among policymakers about current market levels.

The specific concern centers on the forward price-to-earnings multiple. At 22.2x, the S&P 500 is trading above the level it has reached only three times in market history. Each of those periods preceded significant market declines.

Three Times the Market Hit These Valuation Levels—All Ended in Decline

Understanding what happened when valuations last reached these extremes provides crucial context for 2026 market risks:

The Dot-Com Bubble (Late 1990s): As speculative internet stocks captured investor imagination, the S&P 500’s forward PE ratio soared above 22. Investors paid extraordinary prices for companies with minimal earnings. The reckoning came swiftly. By October 2002, the S&P 500 had crashed 49% from its highs.

The COVID-Era Surge (2021): After pandemic stimulus flooded markets, the forward PE ratio again exceeded 22. Investors underestimated how supply chain disruptions and inflation would reshape the economy. By October 2022, the index had fallen 25% from its peak.

The Trump Rally (2024-2025): Following the 2024 election, anticipation of pro-business policies drove stocks higher, pushing the forward PE ratio above 22 once more. Yet tariff announcements and trade policy uncertainty shook confidence. By April 2025, the S&P 500 had already declined 19% from its highs.

The pattern is unmistakable: valuations this expensive don’t stay elevated indefinitely.

Navigating 2026: What Investors Should Know

So will the stock market crash in 2026? The evidence suggests meaningful downside risk, though not necessarily a catastrophic collapse. The combination of historically elevated valuations and midterm election year dynamics creates a challenging environment.

The forward PE ratio of 22.2 doesn’t signal an imminent crash by itself, but it does indicate that the S&P 500 is priced for near-perfection. When combined with the typical market weakness that accompanies midterm elections—especially early in the year—the risk profile tilts unfavorably.

This doesn’t mean investors should flee stocks entirely. The historical data shows that while midterm election years tend to underperform, the recovery typically arrives within months. The key is understanding the terrain ahead: 2026 may test investor patience before the post-election rebound materializes.

Current market conditions reflect both opportunity and peril. Valuations leave little room for disappointment, and election-year uncertainty could trigger volatility. Investors who understand these dynamics and position accordingly may be better prepared for whatever 2026 brings to the stock market landscape.