Bay St. in Toronto's Financial District on Jan. 6. Companies in the S&P/TSX Composite Index have increased profit margins to 15.6 per cent, from 11.6 per cent six years prior, according to FactSet.Cole Burston/The Globe and Mail
How much are stocks going to drop this year? Twenty per cent? Thirty per cent?!
The stench of dread is in the air as 2026 gets rolling. Surely this is the year the stock market gets its comeuppance.
With valuations elevated after two years of spectacular gains, lots of market observers and regular investors alike fear a market crash is in the cards this year.
Relax. The stock market is not as terrifying as it’s being made out to be. The data show that the bull market is based more on corporate performance rather than a late-1990s-style investor hysteria.
Last year, the S&P 500 index of American large-cap companies rose by 18 per cent, after dividends. Almost all of that gain, four-fifths of it anyway, was driven by rising company earnings. Not raging animal spirits. Cold, hard profits.
U.S. blue-chips’ profit margin estimates rose to 14.4 per cent by year-end, up from 13.6 per cent at the start of 2025. They did so despite the enormous jump in tariffs many of them were forced to pay on imported goods.
“American firms are perhaps the most dynamic, well-run, and adaptable companies that we’ve seen in history, and what happened in 2025 underlines that companies were able to boost profits by expanding margins in the face of massive policy headwinds and economic uncertainty,” Sonu Varghese, global macro strategist at Carson Group in Omaha, Neb., said in a recent report.
The same superlatives don’t exactly apply to corporate Canada, which has famously suffered years of chronic underinvestment.
But making money is not really the problem. Companies in the S&P/TSX Composite Index have pushed their profit margins up to 15.6 per cent, from 11.6 per cent six years prior, according to FactSet.
Canada’s big banks, which are among the world’s most profitable, have done much of the heavy lifting. And last year’s gold rally generated a windfall for Canada’s sizable mining sector.
All told, profit growth was the fuel that powered the TSX to a blockbuster 2025, when the benchmark index rose by 32 per cent, after dividends. Rising valuations pitched in for two-fifths of the upside, according to data from Purpose Investments.
There are two ways a stock index can rise over time, broadly speaking: when companies within the index make more money, or when investors collectively decide to pay more and more for each dollar of those profits. This second lever is where investor sentiment comes into play. In a speculative mania, such as the dot-com bubble, valuations get pushed to irrational extremes.
That’s not what’s happening here. By most measures, trading multiples are high, but still within a reasonable range.
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What does that signal to investors? As a starting point, it means that a dollar invested today will likely not make as much money over the long term as a dollar invested when valuations are low.
What it does not tell us is how this year might unfold. The predictive value of stock multiples is close to zero over a one-year period. “It underscores the important market truth that valuation is a horrible market-timing tool,” Liz Ann Sonders, chief investment strategist at Charles Schwab, wrote in a 2026 outlook.
Fact is, the big picture is a good one. Monetary policy is broadly supportive of stocks. Financial conditions – the mix of credit availability, interest rates and risk appetite that signals market health – point to ease rather than stress in the financial sector.
And the corporate sector continues to knock it out of the park on earnings.
By all means, be nervous about valuations. Expectations in financial markets are undeniably elevated.
Every investor should be prepared to weather the kind of major sell-off that valuation alarmists worry is imminent. That doesn’t mean the odds of it happening in 2026 are especially high.