Waiting for the final drop? Morgan Stanley's Wilson: Regardless of midterm election results, it may be a good opportunity to buy the dip in U.S. stocks

Written by Zhang Yaqi, Wall Street CN

Morgan Stanley Chief U.S. Equity Strategist Mike Wilson said the U.S. stock correction since June has entered its final phase, and once the midterm elections held tomorrow conclude, market uncertainty will dissipate significantly, and high-quality cyclicals may present buying opportunities.

In a client report published on Monday, Wilson noted that regardless of the election outcome, the midterm election itself constitutes a classic clearing event. Citing historical data, he said that since 1982, large-cap stocks have risen an average of about 15% (market-cap weighted) to 16% (equal-weighted) in the six months following midterm elections, with the one-year gain expanding further to about 22%.

On election outcomes, Wilson believes a Democratic sweep of both chambers has been fully priced in and does not constitute a major surprise. At the same time, he warned that post-election risks cannot be ignored, with renewed military conflict with Iran and a new round of tariff policies listed as the main potential threats.

Correction nearing its end; market shows bottoming signals

Wilson and his team judge that the current correction is entering its final stage, based on the confluence of multiple market internals.

Among Russell 3000 index constituents, 60% have fallen more than 20% cumulatively from their June highs, while the S&P 500 index has declined in tandem amid narrowing market breadth. Wilson noted that individual stocks falling ahead of the index, followed by the index catching up, is a typical characteristic of markets approaching a bottom historically.

In terms of recent market dynamics, since the end of September, the 10-year Treasury yield has fallen by nearly 40 basis points, and the proportion of S&P 500 constituents trading above their 200-day moving averages has recovered from about 42% to 62%, an increase of about 20 percentage points. The equal-weighted S&P 500 rose nearly 5% during this period, outperforming the market-cap-weighted index by about 6 percentage points. Wilson said this confirms his earlier view that long-term rates are close to a peak and that the equal-weighted S&P 500 is a more attractive expression of broad-market trades.

The Nasdaq 100 index lost trillions of dollars in market capitalization last month and briefly approached technical correction territory. Wilson attributed the main trigger of this correction to market caution about earnings prospects for AI-related companies, and emphasized that investors' evaluation framework has shifted: free cash flow (FCF) gaps are no longer tolerated, earnings sustainability and cash generation capacity are given higher weight, consistent with the typical environment in the late phase of an economic cycle.

Election outcomes have limited impact, while policy variables remain key

On prediction markets Kalshi and Polymarket, the probabilities of a Democratic sweep of both chambers are 71% and 73%, respectively. Wilson believes this scenario has already been absorbed by the market and is therefore unlikely to trigger a major shock.

Even if Democrats achieve full control with a Senate majority, Wilson believes the direct impact may not necessarily be negative: delaying or reversing cuts to Medicaid and food stamp programs could support consumer demand, and corporate investment and M&A activity may accelerate in the short term as companies look to execute before a policy shift in 2028.

However, Wilson emphasized that tariffs, foreign policy, and institutional-level deregulation, policy variables with the deepest market impact over the past two years, remain largely under direct control of the executive branch and will not change with shifts in congressional seats. He wrote that equity markets typically do not, and will not, price two years ahead for a prolonged period.

In a scenario where Republicans retain control of the Senate, with Kalshi showing a probability of about 24%, Wilson believes the market may be forced to look ahead to 2028 and assess the risk that deregulation policies face resistance.

Liquidity replenishment may provide additional support

On monetary policy, Wilson stated clearly that his framework does not assume the Federal Reserve will pivot to rate cuts or introduce additional easing measures.

Instead, he views a decline in the U.S. Treasury General Account (TGA) balance as another liquidity replenishment channel. The Treasury cash balance is expected to fall from about $1.05 trillion currently to about $850 billion by year-end, and as government spending is executed, these funds will flow back into the market, creating a liquidity buffer.

Regarding Russell 2000 small-cap stocks, Wilson remains relatively cautious, believing that for the index to achieve a meaningful recovery, the required decline in rates is still greater than what has already occurred. This means that at the current stage, he prefers allocating capital to large-cap, high-quality cyclical stocks whose valuations have already corrected sufficiently, rather than to small-cap growth.

Source: TechFlow