Investors who exercised patience, resolve and diligence during this past year of excess but unjustified returns will benefit in 2026.Paige Taylor White/The Canadian Press
If 2025 was dominated by the Trump tariff war and the AI capital spending boom, 2026 will be the year in which the equity market bubble gets resolved.
And there is a lot riding on this, because absent the capex and debt binge over the proliferation of data centres, and the equity “wealth effect” on high-end consumers which has driven the personal savings rate sharply lower, the U.S. economy would already be in recession.
The Chinese year of the horse kicks off in February, and I sense we’re shifting into a stumble, not a gait. The biggest risk is that, as was the case with every price bubble that followed a major technological breakthrough, gnawing realization begins to set in that perhaps just a little too much revenue and earnings growth got priced in during the initial wave of uber-enthusiasm. Those who haven’t seen this play out before should read a few history books.
The Shiller cyclically adjusted price-to-earnings ratio has expanded by almost five points since May to 39.5 times, and now exceeds every prior bubble peak in the past century outside of the unprecedented tech mania in the late 1990s and early 2000s. This compares with the 1929 bubble peak of 33 times, the Nifty Fifty peak in the late 1960s of 24 times, and the 1987 precrash peak of 18 times. The average bubble peak in this valuation metric is 26 times. With it now pressing against 40 times – we are in the stratosphere.
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The surge in valuations has coincided with investor sentiment indexes soaring off the charts, which happens to be a contrary negative. Herd mentality. The madness of crowds. An overwhelming consensus. A red flag. When you are priced for perfection, and are expecting perfection, disappointment always follows because the world is not perfect. This is the major theme for 2026 – what I call The Great Reassessment.
This is definitely not the first price bubble in the S&P 500 we have experienced. Remember – a 0.5 standard-deviation represents a plain-vanilla bull market; a one standard-deviation event means we have moved into a mania phase; and breaking above two standard-deviations relative to the historical norm is a definitive bubble. We’ve now moved well above that point.
Generative artificial intelligence has been driving this market euphoria. But we’re not in a bubble in terms of the idea, the concept and the shift in the innovation curve.
The bubble always is in “animal spirits” – that is, it is only a bubble in the behaviour of the investment community as visions of unrealistic future revenue and profit streams get way over their skis.
We moved into an official price bubble in June, 2024, when the S&P 500 reached two standard-deviations relative to the historical norm. The historical record shows that the median length of the time we spend in a bubble phase is 16 months. Therefore, if past is prescient, that would mean the bubble reached its maximum point at the S&P 500 peak back on Oct. 28. History is rhyming.
Nobody ever said you can’t make money in a bubble; the main message is more that the bull market in this phase has gone into “extra innings.” In fact, over this median 16-month length of time that we are in a bubble phase, the S&P 500 makes a median advance of 25 per cent. This time around? Try 27 per cent.
And as is typically the case when the stock market defies gravity in these episodes, everyone from Wall Street strategists to the media to academia wax on about how things are different this time. There is, in fact, no doubt that generative AI is different, just as the internet was back in the late 1990s. What isn’t different is investor behaviour and, as 19th-century Scottish writer Charles Mackay would put it, “the madness of crowds.”
And it is this madness that will naturally dissipate as we move back to sanity in 2026, and benefit only those who exercised patience, resolve and diligence during this past year of excess but unjustified returns, and those with the liquidity to pick up the pieces of shredded balloon as this bubble bursts, as they all do.
David Rosenberg is founder of Rosenberg Research.