At the beginning of last year, the prediction was made that the S&P 500 index would encounter a decline of approximately 10% during 2025. While this forecast was accurate, the scale of the downturn was underestimated. The market experienced a significant sell-off, with the S&P 500 dropping by close to 20% in April, and the Nasdaq Composite index falling even more sharply. This sudden decline was precipitated by unexpected tariff announcements from then-President Donald Trump, which pushed the market near bear market conditions.
However, this downward trend was short-lived. Following subsequent delays and relaxation in tariff policies, the market rallied strongly. As a result, the S&P 500 closed the year with gains exceeding 16%, signaling a robust recovery despite the earlier steep losses.
The fundamental reason cited for the year’s correction was the elevated market valuations creating a fragile environment. Although the magnitude of the April sell-off was not anticipated, the logic underpinning the correction remains valid — high valuations meant that even a relatively small catalyst could trigger a substantial market decline. This concept explains the sensitivity observed in the market movements.
Entering the new year, the market has demonstrated interesting dynamics. Investors have shifted their holdings, moving away from large artificial intelligence (AI) companies toward small-cap stocks and sectors that had previously been undervalued or out of favor. This rotation highlights changing investor sentiment and priorities in the equity landscape.
Looking ahead, the probability of another correction reaching roughly 10% during 2026 appears significant. It is necessary to emphasize that such corrections are not uncommon. According to a 2019 analysis by Guggenheim, since 1946 there have been 84 instances of market declines between 5% and 10%, with the market generally recovering within about one month on average. In addition, there have been 29 declines of between 10% and 20%, which have taken around four months to recover on average.
Furthermore, modern market characteristics, potentially influenced by technology and rapid information dissemination, have contributed to more immediate reactions. This latency reduction increases the likelihood of sizeable market adjustments, underscoring the potential for significant moves in the near term.
While the exact trigger for a potential correction remains uncertain, concern currently centers on inflation and possible disruptions within the AI sector. It remains unclear to what extent previous tariffs have affected consumer prices, and several market professionals are anticipating inflation rates to rise before subsiding later in the year. Prolonged elevated inflation can erode consumer savings and could initiate economic contraction or recession.
Regarding the AI sector, although enthusiasm has waned somewhat, a major negative event has not yet materialized. Such an event could impair progress and cause a sector-wide downturn similar to the dot-com bubble’s impact on the internet industry. The financial interdependence among key companies, such as OpenAI and Nvidia, creates additional risk given the circular flow of capital among vendors and clients.
Importantly, experiencing a correction does not preclude the market from ending the year with gains. Historical precedent demonstrates that the market can absorb such declines and still perform positively over a year. Nevertheless, investors should remain cautious and aware of the risk of increased volatility over the coming months.