2026: Will Expensive Stock Valuations Meet a Midterm Election Setback?

Powell and Fed Officials Sound the Alarm on Market Overheating

When Federal Reserve Chair Jerome Powell remarked in September that equities appeared “fairly highly valued by many measures,” investors barely flinched. The stock market had momentum on its side. Yet as the index continued climbing into year-end, the underlying tension between Powell’s caution and market exuberance only intensified.

Other Federal Reserve officials weren’t subtle about their concerns either. Minutes from October’s policy meeting flagged “stretched asset valuations,” with several governors openly discussing the risk of “a disorderly fall in equity prices.” Fed Governor Lisa Cook doubled down in November, stating her impression that “the likelihood of outsized asset price declines” had risen meaningfully. These aren’t abstract economic musings—they’re signals from the institution that sets monetary policy and shapes financial conditions.

The Valuation Math: When 22 Times Earnings Becomes Dangerous

Here’s where the data gets uncomfortable. The S&P 500 currently trades at 22.2 times forward earnings, according to Yardeni Research. Compare that to the 10-year average of 18.7, and you’re looking at a premium that demands explanation.

But more telling is the historical record. Only three times has the stock market breached that 22 multiple threshold:

The dot-com era (late 1990s): Internet stocks commanded absurd valuations as speculation ruled. When reality hit, the S&P 500 collapsed 49% by October 2002.

The pandemic rebound (2021): Cheap money and supply chain blindness pushed multiples north of 22. By October 2022, the index had surrendered 25% from its peak.

The Trump trade (2024): Election enthusiasm met tariff underestimation. The correction came swiftly—a 19% drop by April 2025.

The pattern is clear: A forward PE above 22 doesn’t guarantee an imminent crash, but it has always preceded severe drawdowns. The question isn’t whether, but when.

Midterm Elections: A Historically Rough Patch

Adding another layer of complexity: 2026 is a midterm election year. That matters more than casual investors realize.

Since the S&P 500 began in 1957, midterm years have returned just 1% on average—a stark contrast to the 9% annual norm. When the sitting president’s party faces headwinds (as often happens in midterms), the pain intensifies. During those cycles, the index has fallen an average of 7%.

Why? Policy uncertainty. When voters shift congressional power, investors don’t know how it reshapes the economic agenda. That ambiguity triggers selling pressure. But here’s the silver lining: once midterm results are digested, markets historically roar back. The six-month stretch from November through April after midterms has averaged 14% returns—the strongest season in any presidential cycle.

The Convergence: Expensive Valuations Meet Electoral Risk

Individually, high valuations and midterm election year dynamics each pose challenges. Together, they create a scenario that demands serious consideration.

Powell’s warning wasn’t alarmist; it was calibrated. When the Federal Reserve flags valuation risk while the stock market refuses to acknowledge it, that divergence tends to resolve—and rarely in the direction investors prefer. Add a midterm election with its inherent policy uncertainty, and 2026 shapes up as a year where conviction should be tempered with caution.

The clock is ticking to December 2026. Whether the market delivers a moderate correction or a deeper setback remains unknowable. What’s certain is that Powell was right to raise the concern, and investors dismissing it risk being caught flat-footed when sentiment eventually shifts.