Warren Buffett’s contrarian strategy says investors should be cautious because bullish sentiment and stock market valuations are high by historical standards.
The S&P 500 (^GSPC 0.02%) has delivered double-digit returns in three straight years, something that has historically preceded lackluster returns in the fourth year.
A down year is particularly plausible in 2026 due to President Trump’s tariffs. His trade policies have already coincided with a weakening jobs market, and recent Federal Reserve research indicates that tariffs have historically been a headwind to economic growth.
Will the stock market crash in 2026? Consider Warren Buffett’s words and actions.
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Warren Buffett cannot predict market crashes, but he has encouraged investors to avoid following the crowd
The Great Recession started in Q4 2007. It was caused by the collapse of the U.S. housing bubble, which itself was driven by lax lending standards on risky subprime mortgages. That debt was bundled and sold as mortgage-backed securities (MBS) to banks and other institutional investors, spreading risk throughout the financial system.
Wall Street was panicking by Q4 2008. Those MBS had plummeted in value as borrowers defaulted, triggering bankruptcies and near-failures that forced the government to bail out dozens (if not hundreds) of financial institutions. In October 2008, with the S&P 500 down 40% from its high, Warren Buffett commented on the situation in an editorial piece in The New York Times. Two quotes are particularly salient today.
- “Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month or a year from now.”
- “A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.”
The first quote teaches that predicting short-term movements in the market is impossible, even for the most successful investors. In fact, Buffett once compared short-term market forecasts to “poison.” He encouraged investors to ignore such things and focus instead on buying understandable stocks at reasonable prices, so long as their earnings are likely to be “materially higher five, 10, and 20 years from now.”
The second quote teaches that investors should avoid following the crowd. Pessimism was widespread when Buffett wrote his editorial piece in 2008, so he recommended buying U.S. stocks. The situation is reversed today. Weekly surveys from the American Association of Individual Investors (AAII) show bullish sentiment has climbed steadily higher in recent months.
That may sound like good news, but the AAII survey is a contrarian indicator. In other words, the S&P 500 tends to deliver higher forward returns when bullish sentiment is lower, and the index tends to deliver lower forward returns when bullish sentiment is higher.
Bullish sentiment is very high right now. It measured 42.5% during the week that ended on Jan. 7, which is well above the five-year average of 35.5%.
Warren Buffett’s Berkshire Hathaway has been a net seller of stock for three straight years, presumably due to rising valuations
Under Warren Buffett’s lead, Berkshire Hathaway has been a net seller of stock — meaning the value of stock the company sold exceeded the value of stock it purchased — for the last three years. That period coincided with a substantial increase in the stock market’s forward price-to-earnings (P/E) multiple.
To elaborate, the S&P 500 traded around 15.5 times forward earnings in October 2022, but the index now trades at 22.2 times forward earnings, a meaningful premium to the five-year average of 20 and the 10-year average of 18.7, according to FactSet Research.
Interestingly, the S&P 500 has only sustained a forward P/E ratio higher than 22 during two periods in the last four decades: the dot-com bubble and COVID-19 pandemic. The index fell into a bear market both times. That does not necessarily mean the S&P 500 will crash (or even decline) in the near future, but it does hint at weak returns.
Torsten Slok, chief economist at Apollo Global Management, says forward P/E multiples around 22 have historically correlated with annual returns below 3% in the next three years. That outcome is particularly plausible in the current environment because sweeping tariffs imposed by President Trump are likely to slow economic growth, according to numerous experts.
No one knows for certain whether the stock market will crash this year, but elevated levels of bullish sentiment and historically high valuations hint at greed. Buffett’s contrarian philosophy says investors should be fearful in such environments. And his actions before retiring as Berkshire Hathaway’s CEO at the end of 2025 reinforced that message.
