Morgan Stanley believes the current correction in US equities could be approaching its final stages, with the upcoming midterm elections and several other developments potentially clearing the way for a market recovery.
In a research note, strategist Michael Wilson said the stock market has been adjusting to a mid-cycle transition since June, with slowing Federal Reserve balance sheet growth, tighter capital availability and political uncertainty contributing to the weakness.
The investment bank maintains a year-end S&P 500 target of 8,000, although it sees potential near-term downside to between 7,100 and 7,200, slightly below the index’s 200-day moving average.
Midterm Elections Could Help Stabilise Markets
Morgan Stanley identified three developments that could help bring the correction to an end.
The first involves artificial intelligence, where concerns about capital availability, financing costs, safety and local opposition to data centre development are expected to intensify over the next three to four weeks.
The second is the November 3 midterm elections, which Wilson believes could remove a significant source of market uncertainty.
“Midterm elections are typically a market headwind initially and usually then lead to very strong 6-12 month returns post the event,” Wilson wrote.
However, he cautioned that market conditions could remain unsettled for several days or weeks following the vote.
Liquidity Remains the Biggest Market Risk
The third factor is tightening financial conditions, driven by Federal Reserve interest rate increases, slower balance sheet expansion and rising energy prices.
“Of all the concerns, we think liquidity presents the biggest risk and catalyst for a final low,” Wilson said.
The strategist noted that Federal Reserve Chair Kevin Warsh took office committed to returning inflation to the central bank’s 2% target, although policymakers have raised interest rates only once since his appointment.
Meanwhile, longer-term Treasury yields have increased by more than 100 basis points since February, adding pressure to borrowing costs and financial markets.
Fed Policy Shift Could Support a Recovery
Wilson believes tighter financial conditions could eventually slow economic growth and reduce inflationary pressures.
However, a more pronounced market downturn could also prompt the Federal Reserve to reconsider its monetary policy stance, potentially supporting equity prices.
“That would be asset price bullish in the short term even if it implies a more extended path to reaching the Fed’s inflation goals,” Wilson said.
Morgan Stanley’s outlook suggests further weakness remains possible before the market establishes a lasting low, but the resolution of election uncertainty, AI-related concerns and liquidity pressures could provide the foundation for a recovery.