What's Next for Equities in 2026: Three Market Scenarios Worth Considering

The Broader Picture

As we transition into 2026, the stock market stands at a crossroads. The S&P 500 Index has posted remarkable gains—tracking toward an 18% advance by year-end 2025—extending a three-year rally that saw 24% and 23% returns in 2023 and 2024 respectively. Yet behind these impressive numbers lies a question that keeps many investors awake: are valuations sustainable, or have we simply gotten too comfortable with extraordinary results?

The answer isn’t straightforward. While economic fundamentals remain reasonably intact and the Federal Reserve has shifted toward rate reductions, uncertainty about 2026 feels palpable. This is precisely the environment where investors must think carefully about what could happen—both the upside and the downside—when stock market will go up, and equally important, when it won’t.

Scenario 1: A Pullback Is Likely (But Not Catastrophic)

Let’s start with what many market participants are reluctant to discuss openly: the S&P 500 is trading at valuations well above long-term historical averages based on price-to-earnings multiples. This matters because it leaves little room for disappointment.

Several catalysts could trigger a 10% correction in 2026:

Inflation doesn’t cooperate. If price pressures remain sticky or re-accelerate, the Federal Reserve may pause its rate-cutting cycle sooner than investors expect—or worse, reverse course entirely. This would fundamentally alter the narrative that has supported stock prices.

Labor markets weaken. A rise in unemployment or softer consumer spending patterns would immediately shift focus toward recession risks, prompting investors to reassess equity prices.

Geopolitical or macro surprises. Tariff escalations, policy shifts, or unforeseen international developments could unsettle markets faster than anticipated.

Historically, this isn’t unusual territory. According to data from Charles Schwab, there have been 25 market corrections of at least 10% since 1974. Here’s the encouraging part: only six of those evolved into true bear markets. This means a meaningful pullback doesn’t automatically spell disaster for annual returns or longer-term wealth building.

Scenario 2: The Artificial Intelligence Trade Still Has Oxygen

The AI narrative has driven some of the most eye-popping valuations we’ve seen in modern markets. Stocks like Palantir, Tesla, and Nvidia have compounded wealth for early believers, yet their current price-to-earnings ratios suggest we’re in bubble territory by historical standards.

The bulls would counter with a fair point: massive hyperscalers have already committed hundreds of billions to AI infrastructure and plan to deploy trillions more. That’s real capital, real investment, and real conviction about the technology’s potential.

What makes this situation tricky is that calling the end of a bubble is nearly impossible to time. Consider the late-1990s internet boom—investors who correctly identified the excess but exited too early missed years of additional gains before the eventual crash. Many of the companies currently powering the AI wave maintain fortress-like balance sheets and genuine profitability, which distinguishes this from some past speculative episodes.

The bottom line: while overvaluation exists, the stock market will go up in sectors tied to AI infrastructure, data analytics, and computational power because these businesses still command structural tailwinds. Whether that occurs smoothly or with volatility in 2026 is a separate question.

Scenario 3: The Year Will Likely Close in Positive Territory

Despite the legitimate concerns outlined above, the base case for 2026 tilts toward continued gains.

The Fed remains accommodative. Expectations for additional interest rate cuts persist, and the Fed has already resumed balance sheet expansion—currently purchasing $40 billion in short-term Treasury bills monthly to stabilize lending markets. This is not officially labeled quantitative easing, but the effect is comparable: it pumps liquidity into the financial system. The central bank intends to moderate this pace sometime during 2026, though the exact timing remains fluid.

As legendary investor David Tepper famously noted, “Don’t fight the Fed.” The institution remains positioned to support risk assets through 2026.

Recession doesn’t necessarily mean market disaster. Even if economic growth moderates or a mild recession materializes, the Fed would almost certainly respond with more rate cuts. This reversal would actually support equity valuations by reducing discount rates. The real danger emerges only if inflation persists—that’s the scenario that could genuinely derail policy support.

Most Wall Street strategists expect inflation to rise modestly early in 2026 before gradually declining through year-end. That trajectory wouldn’t force the Fed’s hand.

Sector rotation creates new opportunities. The concentration in mega-cap technology and AI-related stocks has been historically extreme. A broadening of leadership toward industrial names, financials, materials, and other S&P 500 constituents with more modest valuations could attract capital and support overall market advances even if mega-cap momentum cools.

Policy tailwinds are real. Depending on how tariff policies evolve, corporate tax adjustments, and regulatory clarity emerges from Washington, multiple industries stand to benefit. These factors could continue providing support across diverse equity sectors.

Putting It Together

The 2026 market outlook isn’t binary. Yes, a 10% correction is probable at some point—corrections are a normal feature of healthy markets, not an anomaly. But no, that doesn’t preclude the stock market will go up on a full-year basis. Economic resilience, Fed support, technological opportunity in AI, and policy catalysts all point toward positive returns despite the inevitable volatility and bumps along the way.

The real risk isn’t a modest pullback; it’s sustained inflation that forces the Fed to abandon its supportive stance. That remains the bear case, but it’s not the consensus expectation heading into next year. For now, the preponderance of evidence suggests equity markets have more room to run in 2026, even if the journey gets a bit bumpier than the prior three years.