I wrote in January that the economy and corporate earnings remained strong enough to avoid a major market sell-off. I predicted that the S&P 500 (^GSPC 0.61%) would deliver single-digit gains in 2026.
Do I still think the chances are good that the S&P 500 will rise modestly by the end of 2026? Yes. I’m not backing away from my prediction.
However, the market dynamics are now significantly different from those at the beginning of the year. My opinion is that a stock market crash is much more likely now than it was just two months ago.
Image source: Getty Images.
Shock and awful
If you’ve watched the news at all in recent weeks, you probably know exactly why I think there’s now a higher probability of a stock market crash. The attack on Iran by the U.S. and Israel — and, more importantly, the resulting reaction by Iran — has dramatically increased the risk of a market meltdown.
Iran’s attempt to block traffic through the Strait of Hormuz is taking a steep toll. The situation is dire enough that President Trump stated that the U.S. Navy could escort oil tankers through the narrow passage to the Gulf of Oman “if necessary.”
Oil prices have soared in the wake of these events. The current conflict is the greatest disruption to global oil supply ever, and it is nearly three times the impact of the 1973 Arab oil embargo, according to Rapidan Energy. That oil crisis, by the way, led to one of the worst stock market crashes since the Great Depression.
Many American consumers were already pinching pennies due to higher prices following the COVID-19 pandemic. The possibility of resurgent inflation is now much more concerning. Because of this fear, the Federal Reserve seems likely to delay further interest rate cuts that investors were hoping for.
Feeling bubblier
Despite all of this uncertainty, the S&P 500 hasn’t dipped much below its all-time high so far. That’s good news, right? Yes, but it also means valuations remain sky-high.
The S&P 500 Shiller CAPE (cyclically adjusted price-to-earnings ratio) is close to its highest level since early 2000. If you’re a stock market history buff, you’ll probably recall that the dot-com bubble burst that year.
The ratio of total stock market capitalization to GDP, known as the Buffett indicator after legendary investor Warren Buffett popularized it, stands at roughly 218%. Buffett wrote in a 2001 Fortune article that investors are “playing with fire” if this ratio approaches 200%.
Granted, valuation metrics aren’t all that different from what they were earlier in the year. But we’re already seeing increased concerns about tech giants’ investments in artificial intelligence (AI) infrastructure and a sell-off in SaaS stocks due to fears of AI disruption to their businesses. The more investors sense that the market is in a bubble, the greater the chances of a crash. And the market is feeling bubblier now than two months ago.
Walking a tightrope
Investing in stocks is always similar to walking a tightrope. There’s a constant risk of falling. However, investors today are walking this metaphorical tightrope over a canyon of geopolitical and macroeconomic uncertainty.
Again, I’m emphatically not predicting a stock market crash. But has the probability of such a crash increased over the last two months? I think so.
The best strategy for investors in light of the current market dynamics, in my view, is to do three things:
- Most importantly, don’t panic. Just because the risk of a stock market crash may be greater doesn’t mean that one is definitely on the way.
- Be highly selective in which stocks you buy, paying especially close attention to valuation, financial strength, and growth prospects.
- Increase your cash position to be ready to take advantage of a sell-off if it occurs.
Maybe the stock market will plunge; maybe it won’t. If you follow the three steps above, you should be in good shape over the long term either way.
