Is a Market Crash Coming in 2026? What Federal Reserve Warnings Reveal About Stock Valuations

As we move deeper into 2026, investors face a critical question: Is a market crash coming? The answer may lie in recent warnings from the nation’s highest financial officials. In fall 2025, Federal Reserve Chair Jerome Powell sounded an alarm that continues to reverberate through Wall Street. “By many measures,” he cautioned, “equity prices are fairly highly valued.” Since then, the S&P 500 has climbed further, pushing valuations into increasingly dangerous territory—a pattern that historically has preceded significant market declines.

The stock market rallied 16% in 2025, marking the third consecutive year of double-digit gains for the benchmark index. Yet beneath this impressive performance lies a sobering reality: valuations have stretched to levels seen only a handful of times in history, each preceded by a sharp correction. Combined with the headwinds typical of midterm election years, the stage appears set for a challenging period ahead.

Elevated Valuations: A Red Flag That History Cannot Ignore

Federal Reserve officials have grown increasingly vocal about stock market risks. Beyond Jerome Powell’s September warning, the October meeting minutes from the FOMC disclosed that “some participants commented on stretched asset valuations in financial markets, with several of these participants highlighting the possibility of a disorderly fall in equity prices.” Fed Governor Lisa Cook reinforced this message in November, stating, “Currently, my impression is that there is an increased likelihood of outsized asset price declines.”

These are not casual observations. They reflect deep concern from institutions tasked with maintaining financial stability. The Fed’s latest Financial Stability Report specifically flagged the S&P 500’s forward price-to-earnings ratio as “close to the upper end of its historical range.” According to Yardeni Research, the S&P 500 currently trades at 22.2 times forward earnings—a meaningful premium to the 10-year average of 18.7.

This valuation matters because it has preceded every major market decline of the past three decades. The historical record is unambiguous:

The Dot-Com Era (Late 1990s): Investors bid the S&P 500’s forward PE ratio above 22 as speculative internet stocks commanded absurd valuations. The resulting crash saw the index plunge 49% by October 2002. The Pandemic Aftermath (2021): With forward earnings estimates revised downward due to supply chain disruptions and inflation surprises, the S&P 500’s PE ratio again topped 22. By October 2022, the index had dropped 25% from its high. The Trump Rally (2024-2025): Most recently, optimism around the new administration pushed valuations above 22x forward earnings in 2024. By April 2025, that exuberance had reversed, and the S&P 500 had surrendered 19% from its peak.

The message is clear: A forward PE ratio exceeding 22 does not guarantee an imminent market crash, but it does signal that sharp declines have historically followed such valuations. We are in that territory now.

Midterm Election Years: A Structural Headwind

Adding to the concern is the predictable pattern that unfolds during midterm election years. Since the S&P 500’s inception in 1957, the index has passed through 17 midterm elections. The results have been disappointing for buy-and-hold investors. The average return during those years stands at just 1%—far below the 9% annual average since 1957.

The underperformance intensifies when a sitting president’s party faces the electorate. During midterm elections where the incumbent president’s party is up for vote, the S&P 500 has declined by an average of 7%. Why? Elections introduce policy uncertainty. Markets dislike uncertainty. Investors become cautious about deployment of capital when unsure whether the current administration’s economic agenda will survive Congressional scrutiny.

However, there is a silver lining. The uncertainty dissipates quickly once the election results are final. According to Carson Investment Research, the six months following midterm elections—typically November through April—have historically delivered the strongest returns of the four-year presidential cycle. The S&P 500 has averaged 14% returns during that post-election period, suggesting that patient investors who hold through the temporary turbulence can be rewarded.

Putting the Pieces Together: What This Means for Your Portfolio

The convergence of elevated valuations and midterm election timing creates a challenging backdrop for stock market investors in 2026. While neither factor alone guarantees a market crash, their combination warrants caution. History provides no guarantees, but it does offer guidance: When valuations reach the upper bounds of their historical range alongside cyclical election-year headwinds, downside risk merits serious consideration.

For those still determining whether to maintain or increase stock exposure, the Federal Reserve’s warnings deserve weight. The central bank’s officials are not in the business of casual commentary. When Jerome Powell, Lisa Cook, and the FOMC collectively flag valuation concerns, they are signaling that risk has shifted. A market crash may not be inevitable in 2026, but the odds have risen materially above average.

The most prudent approach? Ensure your portfolio reflects both your risk tolerance and your time horizon. Those who can weather a temporary downturn may find that 2026’s volatility creates opportunity. Those seeking to reduce exposure now have ample reason to act.