Is a Stock Market Crash Coming in 2026? What the Fed's Signals Tell Us

Fed Officials Sound the Alarm on Equity Valuations

Federal Reserve Chair Jerome Powell set off alarm bells in September when he told investors that stock prices were “fairly highly valued by many measures.” His message wasn’t isolated—it reflected growing concern within the central banking establishment about stretched asset prices.

The concern intensified as the year progressed. Fed Governor Lisa Cook warned in November that “the likelihood of outsized asset price declines has increased.” Minutes from October’s Federal Open Market Committee meeting went even further, with participants cautioning about the possibility of “a disorderly fall in equity prices.”

What’s driving this collective hand-wringing from America’s monetary authorities? The numbers tell the story.

The Valuation Problem That Haunts Markets

The S&P 500 currently carries a forward price-to-earnings multiple of 22.2—well above the 10-year historical average of 18.7. This elevated valuation is not a minor statistical blip. According to the Federal Reserve’s Financial Stability Report, the index sits near the upper boundary of its historical valuation range.

Looking back at market history reveals a troubling pattern: whenever the S&P 500 has traded at forward PE ratios above 22, the subsequent correction has been severe.

Three historical precedents stand out:

During the late 1990s tech euphoria, the forward PE soared above 22 as investors chased speculative internet stocks. The subsequent collapse wiped out 49% from the peak by October 2002. Fast forward to 2021, when pandemic stimulus and underestimated inflation sent the forward PE above 22 again. Investors didn’t see the correction coming, but the S&P 500 fell 25% from its high within 13 months. Most recently, 2024 saw the forward PE climb above 22 following President Trump’s election victory. Market participants focused on tariff-friendly policies but underestimated the actual impact. By April 2025, the index had declined 19% from its high.

The takeaway is clear: an expensive valuation doesn’t guarantee an immediate crash, but it consistently precedes sharp corrections.

The Midterm Election Headwind

Adding to the bearish backdrop is the electoral calendar. The S&P 500 has participated in 17 midterm election cycles since 1957, and the performance record is mediocre at best. During these years, the index has returned just 1% on average—a stark contrast to the historical 9% annual average.

The performance becomes genuinely poor when the incumbent president’s party faces electoral headwinds. The S&P 500 has typically declined about 7% during midterms held under a president of the same party that controls Congress at the time.

Why the weakness? Midterm elections inject policy uncertainty into the market equation. Investors worry about whether political shifts will upend economic priorities and regulatory frameworks. This uncertainty creates selling pressure as capital holders sit on the sidelines awaiting clarity.

However, history suggests relief comes relatively quickly. The six months following midterm elections—roughly November through April—have historically delivered the strongest returns of any period in the four-year presidential cycle. Carson Investment Research data shows the S&P 500 has averaged 14% returns during this post-election rebound window.

Connecting the Dots: A Perfect Storm in 2026?

The S&P 500 delivered 16% returns in 2025—its third consecutive year of double-digit gains. This impressive streak masks underlying vulnerabilities heading into 2026.

Combining elevated valuations with midterm election-year seasonality creates a plausible scenario for near-term market stress. While the Federal Reserve’s warnings don’t signal an impending catastrophe, they do suggest investors should maintain realistic expectations and guard against complacency about equity market risks.