Morgan Stanley expects several upcoming developments to help resolve the current downturn in US stocks, although the bank believes the S&P 500 could experience further losses before a sustained recovery begins.
Strategist Michael Wilson said equities have been undergoing a mid-cycle adjustment since June, with reduced liquidity, tighter access to capital and uncertainty surrounding the US midterm elections weighing on sentiment.
The bank’s tactical downside forecast places the S&P 500 between 7,100 and 7,200, implying a modest move below its 200-day moving average. Its base-case target for the end of 2026 remains unchanged at 8,000.
Political and AI Uncertainty Could Ease in Coming Weeks
Wilson highlighted three potential turning points for the market, beginning with concerns surrounding artificial intelligence investment.
Questions about the supply and cost of capital, AI safety and community opposition to data centre construction are expected to become more prominent over the next three to four weeks.
The November 3 midterm elections represent another important development.
“Midterm elections are typically a market headwind initially and usually then lead to very strong 6-12 month returns post the event,” Wilson wrote.
While historical patterns suggest that markets have often strengthened following midterm elections, Wilson warned that the adjustment could remain volatile for days or weeks after the event.
Tightening Financial Conditions Could Trigger a Final Market Low
Morgan Stanley considers reduced liquidity the most significant threat to equities.
Higher Federal Reserve interest rates, slower expansion of the central bank’s balance sheet and elevated energy costs have contributed to tighter financial conditions.
“Of all the concerns, we think liquidity presents the biggest risk and catalyst for a final low,” Wilson said.
He noted that Fed Chair Kevin Warsh entered office focused on bringing inflation back to 2%, although the central bank has implemented only one rate increase during his tenure.
Longer-term Treasury yields have risen by more than 100 basis points since February, creating additional pressure on financing conditions.
Market Weakness Could Encourage a Federal Reserve Pivot
Wilson suggested that tighter monetary conditions could eventually restrain economic activity and help ease inflation.
However, if financial markets experience additional stress, the Federal Reserve could face pressure to change course, potentially providing near-term support for asset 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 analysis indicates that the S&P 500 may still face a final period of weakness, but the combination of reduced political uncertainty and a possible shift in financial conditions could help support a subsequent rebound.
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