Morgan Stanley sees post-election relief for S&P 500

Morgan Stanley told clients in a Monday note that upcoming clearing events, including the midterm elections, should mark the end of the current equity correction. Strategist Michael Wilson stated that markets have been adjusting to a mid-cycle transition since June, a period exacerbated by slowing growth in the Federal Reserve's balance sheet, capital scarcity, and the midterms. While quality stocks have consistently led during this shift, Wilson noted they are now breaking out.

The bank has set a tactical downside target for the S&P 500 at 7,100 to 7,200, representing a slight break of the 200-day moving average. Its year-end base case remains at 8,000. Wilson identified three specific clearing events that could drive market direction in the near term.

The first event involves AI-related concerns regarding the supply and cost of capital, safety, and NIMBYism. Wilson expects these issues to come to a head over the next three to four weeks. The second event is the midterm elections. In the note, Wilson wrote that midterm elections are typically an initial market headwind but usually lead to very strong 6- to 12-month returns after the event. He cautioned that the path could be messy and may linger for days or weeks after election day.

The third clearing event is tightening financial conditions, driven by Federal Reserve rate hikes, slower balance sheet growth, and higher energy prices. Wilson stated that liquidity presents the biggest risk and catalyst for a final low among all current concerns. He noted that Fed Chair Kevin Warsh took office with a strong commitment to returning inflation to 2%, but the Federal Reserve has hiked rates only once since then.

Back-end rates have risen more than 100 basis points since February. Wilson explained that this tightening could slow growth and inflation, but it could also cause market stress that leads to a Fed pivot. Such a pivot would be asset price bullish in the short term, even if it implies a more extended path to reaching the Federal Reserve's inflation goals.