Dec. 31, 2025
As ever, the biggest question for investors to ponder over the coming year is an impossible one: are share prices set to soar or plunge? The answer will determine not only whether shareholders have a brilliant or dreadful time, but whether stockpickers have made winning choices and asset allocators have chosen wise portfolio weights. Individual investors have the luxury of ignoring the question and remembering, from previous booms and busts, that buy-and-hold is a difficult strategy to beat. Professionals, though, are paid to do just that, and so must attempt to guess the future. What, then, do they make of the prospects for 2026?
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Start with how shares are priced today. Everyone knows that American stocks have been expensive for some time, and those of the biggest technology firms even more so. However, such companies are no longer the only pricey ones. Analysts at Goldman Sachs calculate that globally, relative to underlying earnings expected over the coming year, stock prices are now higher than they have been for 90% of the time over the past two decades. The bankers note that this is also true of American shares excluding big tech, and of shares listed outside America. Although in some countries, such as Britain and China, stocks are not quite so dear relative to their recent history, almost nowhere do they look cheap.
In other words, a bull market that was once fuelled by bets on American exceptionalism and the profitmaking potential of artificial intelligence has become far broader. Some traders, it is true, will be buying expensive shares simply because they believe they will soon be able to sell them on for even more. Should this mentality become widespread, prices would rise far above the level that underlying earnings could justify, and the risk of a crash would loom large. Assuming investors in aggregate remain rational, however, high valuations amount to a bet that corporate profits are set to grow unusually fast across much of the world.
If this bet is correct, rising earnings could fuel steady returns for shareholders in spite of stocks’ expensive starting point. Broadly speaking, this is what the Wall Street strategists who earn their living by advising investors think will happen in 2026. A recent survey by Bloomberg, a data provider, shows that the average such strategist expects America’s S&P 500 share index to climb by 9% over the coming year. This would be a decent return but an unspectacular one, since over the past three years it has risen at an annualised 23%. Although the forecasters had a range of views around this average, it was the narrowest since at least 2018. The most bearish thought that the index would rise by 1%, the most bullish by 18%.
Whatever their point estimates for where stock prices will end the year, fund managers must also worry about the risk of an explosion. And so another way of gauging their expectations is to look at the market price of protection against such a risk. If you believe that a blow-up is unlikely, but still want to guard against some of the damage one would bring, you might buy a “put” option on the index. This is a contract giving you the right, but not the obligation, to sell the basket of stocks in the index at a pre-set price (the “strike”). Choose a strike that is, say, 30% below the index’s current level, and you are protected from any losses beyond that point.
The prices of such contracts therefore contain information about the probability that traders assign to a stockmarket crash. Victor Haghani and James White, both of Elm Wealth, an investment firm, have crunched the numbers for options on the S&P 500. They reckon that the market assigns a probability of around 8% to a severe plunge (meaning one to a trough that is more than 30% below the current level) at some point in 2026. Although non-negligible, this probability is barely higher than the historical frequency of similar drawdowns, which has been around 7% over the past century.
Options traders, then, do not seem overly worried about a stockmarket crash. In fact, they are more concerned about missing out if prices leap far higher than expected. The price of options that would pay out if the S&P 500 jumped by 30%, calculate Messrs Haghani and White, implies that the probability of this is around 11%. To those who fear stocks are in a bubble, this will not offer much comfort. After all, the people buying such options might well be the same bullish lot who have bid share valuations to their current heights.■
This Economist article was legally published by AdvisorStream.
