High Valuations Don't Guarantee Falling Stock Prices in 2026

The author argues that investors can correctly predict falling price-to-earnings ratios but still make a major mistake by using that prediction to sell stocks. The author argues that elevated valuations do not mean stock prices are likely to fall soon. Ten months into 2026, price-to-earnings ratios have contracted even as stock prices trended higher. Aggressive, ongoing upward revisions to earnings forecasts have reduced the ratios because forecast earnings have risen faster than prices.

The author launched TKer five years ago, on October 14, to explain how the stock market usually rises. TKer's first year included a bear market as the Federal Reserve fought inflation. The S&P 500 fell 19% during that year. TKer's second year began two days after the current bull market started. The S&P 500 rose 21% during the second year despite lingering uncertainty. The S&P 500 rose 35% during the third year. The average annualized return from TKer's launch through the third year was 9%.

TKer's fourth year brought political upheaval after the U.S. presidential election and trade wars sparked by new tariffs. The fourth year also brought volatility in interest rates and currency markets, heightened geopolitical tensions and threats to Federal Reserve independence. A government shutdown added to concerns about economic data quality. However, the stock market repeatedly reached new all-time highs and climbed 14% during the fourth year, arguably because earnings were resilient.

Many fourth-year challenges continued into TKer's fifth year. The forward price-to-earnings ratio was close to 23 times at the previous annual update, the highest level since 2020. However, the S&P 500 climbed 16% during TKer's fifth year.

About a year ago, some prominent Wall Street strategists predicted that high valuations were justified and would remain elevated in 2026 as stock prices rose. Other strategists argued that valuations constrained returns and risked contracting, limiting price returns. The author argues that price-to-earnings ratio forecasts often undermine Wall Street's year-end price-target calculations because short-term changes in the ratio are difficult to predict. The author argues that expensive stocks often become more expensive and cheap stocks often become cheaper. The author also argues that prices sometimes fall as stocks become more expensive, while prices sometimes rise as stocks become cheaper.