Investors should buckle up for a potential stock market correction, warns Morgan Stanley’s Chief U.S. Equity Strategist, Michael Wilson. While the S&P 500 (SPX) and Nasdaq Composite (COMP) have enjoyed a stellar run in 2024, Wilson sees a 10% pullback as “highly likely” between now and the upcoming U.S. elections.
This anticipated correction, Wilson argues, wouldn’t be driven by the election itself, but rather by the surrounding cloud of uncertainty. Key factors like corporate earnings, Federal Reserve policy, and the overall political climate are likely to weigh heavily on investor sentiment in the coming months.
Ignoring Risks, Betting on Winners
Equity investors, according to Wilson, have been content to overlook these mounting risks for the time being. Faced with tepid earnings growth across a broad swathe of companies, they’ve turned their attention to a select group of high-quality growth stocks that have delivered explosive profit surges in the past year.
While this strategy has paid off to some extent, Wilson cautions that it’s not sustainable in the long run. The current dynamic where “bad news is good news,” meaning weak economic data prompts the Fed to ease monetary policy, could backfire spectacularly. Eventually, investors will need to confront the possibility that this supportive environment won’t last forever.
Monetary Policy and Election Jitters: A Catalyst for Correction
Adding fuel to the potential correction fire is the uncertainty surrounding both Federal Reserve policy and the upcoming elections. The Fed’s stance on interest rates and future monetary policy adjustments will be closely scrutinized by markets, and any unexpected shifts could trigger a selloff. Similarly, the election season, with its inherent political volatility, is likely to inject further anxiety into the market.
A Choppy Third Quarter and a Cautious Outlook
Looking ahead, Wilson anticipates a choppy third quarter for the markets. He believes the S&P 500’s chances of finishing the year at or above its current levels are slim, with a probability of only around 25%.
A Shift in Stance, But Caution Remains
It’s worth noting that Wilson, known for his historically bearish outlook, has recently adopted a slightly more optimistic stance. He recently revised his S&P 500 target upwards, projecting the index to hit 5,400 by mid-2025. This comes on the heels of the S&P 500 struggling to maintain its recent winning streak.
The Narrow Market: A Double-Edged Sword
Wilson highlights the historically low level of participation in the S&P 500’s rally this year. While this might raise concerns about an impending market crash, Wilson suggests that history offers a more nuanced perspective. Historically, such narrow market advances haven’t necessarily translated into imminent breakdowns. The data implies an equal chance that either the rest of the market catches up to the megacap leaders, or the megacaps falter, dragging the broader indexes down with them.
Conclusion
Investors would be wise to heed Morgan Stanley’s Michael Wilson’s warnings. While the stock market may not be on the brink of collapse, a 10% correction appears to be a distinct possibility in the near future. Uncertainty surrounding key factors like earnings, Fed policy, and elections is poised to dampen investor sentiment. As Wilson suggests, a more cautious approach might be prudent in the coming months. Investors may want to consider diversifying their portfolios beyond the select group of high-growth stocks that have fueled the market’s recent rise. By acknowledging the potential risks and remaining vigilant, investors can navigate the upcoming market turbulence with greater confidence.
