Stocks likely headed for a 10% pullback in the third quarter, Morgan Stanley's Wilson warns

By Joseph Adinolfi

Investors should start preparing for a stock-market correction as uncertainty surrounding U.S. politics, corporate earnings and Federal Reserve policy start to weigh on the market, according to Morgan Stanley's Michael Wilson.

"The chance of a 10% correction is highly likely between now and the election," Wilson said. "Not because of the election but because uncertainty is likely to prevail," Wilson said during an interview with Bloomberg Television on Monday.

See: Why stocks could see a 10% pullback later this year

Equity investors have managed to ignore these risks so far, Wilson said. Their solution for tepid earnings growth exhibited by most companies has been to bet on a handful of high-quality growth stocks that have seen profits boom over the past year.

While the strategy has generally worked, investors eventually will be forced to reckon with the possibility that the "bad news is good news" economic dynamic that has recently helped to prop up stocks could ultimately come back to bite them.

Uncertainty surrounding the outlook for monetary policy and the election, also could be catalysts for the market to fall in the coming months. He pegged the chances of the S&P 500 finishing the year at, or above, its current level is only about 25%.

The third quarter is going to be "choppy," Wilson said.

Wilson has recommended that investors focus on growth stocks that have, for the most part, led the rally in the S&P 500 SPX and Nasdaq Composite COMP this year. Known for his bearish views, the Morgan Stanley strategist recently turned a touch more optimistic lately, raising his target for the S&P 500 and calling for the index to hit 5,400 by mid-next year.

To be sure, the index was trading above that level on Monday as the S&P 500 struggled to lock in its fifth straight daily advance - what would be its longest winning streak since January.

The Morgan Stanley strategist noted that while the level of participation in the S&P 500's advance this year has been "historically low," data suggest that this doesn't necessarily mean stocks are headed for a bust-up.

Instead, history shows the chances that the rest of the market rallies to catch up with the megacap stocks are roughly equal to the possibility that the megacaps give out, taking the indexes down with them.

-Joseph Adinolfi

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07-08-24 1544ET

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