Morgan Stanley's chief U.S. equity strategist, Mike Wilson, stated that the adjustment in U.S. stocks since June has entered its "final stage." Once tomorrow's mid-term elections are over, market uncertainties will significantly diminish, and high-quality cyclical stocks may present buying opportunities.
In a client report released on Monday, Wilson pointed out that regardless of the election results, the mid-term elections themselves constitute a classic "cleaning event." Citing historical data, he noted that since 1982, large-cap stocks have averaged a gain of about 15% (market value weighted) to 16% (equal weight) within six months after mid-term elections, and this gain has further expanded to about 22% in the following year.
At the level of election results, Wilson believes that the scenario where the Democratic Party sweeps both houses has been fully priced in by the market and does not constitute a major surprise. At the same time, he also warns that post-election risks cannot be ignored – a renewed military conflict with Iran and a new round of tariff policies are listed as the main potential threats.
The adjustment is coming to an end, and the market is showing signs of a bottom.
Wilson and his team believe that the current adjustment is entering its final phase, based on the resonance of multiple internal market indicators.
Among the constituents of the Russell 3000 index, 60% have already seen a cumulative decline of more than 20% since their June highs, while the S&P 500 index has also followed suit as the market breadth has narrowed. Wilson points out that the pattern where individual stocks fall before the index and then the index catches up in decline is a typical characteristic when the market is approaching a bottom in history.
Looking at recent market trends, since the end of September, the yield on 10-year U.S. Treasury bonds has fallen by nearly 40 basis points. The proportion of S&P 500 constituents that have crossed above their 200-day moving average has risen from about 42% to 62%, an increase of about 20 percentage points. During this period, the equal-weight S&P 500 index has risen by nearly 5%, outperforming the market capitalization-weighted index by about 6 percentage points. Wilson indicates that this confirms previous assessments—that long-term interest rates are nearing their peak, and the equal-weight S&P 500 is a more attractive option for 'wide-based trading'.
The Nasdaq 100 index lost trillions of dollars in market value last month, briefly approaching a technical correction zone. Wilson attributed the main cause of this round of adjustment to the market's cautious attitude towards the profit prospects of companies related to AI, and emphasized that investors' evaluation frameworks have shifted—shortfalls in free cash flow (FCF) are no longer tolerated, with profit sustainability and cash generation capacity receiving greater weight. This is consistent with the typical environment in the later stages of an economic cycle.
The impact of the election results is limited; policy variables remain the key.
In the prediction markets Kalshi and Polymarket, the probability of the Democratic Party sweeping both houses is 71% and 73%, respectively. Wilson believes that this scenario has already been factored into by the market, so it is unlikely to cause a significant impact.
Even if the Democratic Party achieves full control with a majority in the Senate, Wilson believes that the direct impact may not necessarily be negative: delaying or reversing the cuts to medical subsidies and food stamps is expected to support consumer demand; in order to take advantage of the situation before the policy shift in 2028, companies may also accelerate their investment and mergers and acquisitions activities in the short term.
However, Wilson emphasizes that tariff measures, foreign policy, and deregulatory actions at the institutional level, which have been the most influential policy variables on the market in the past two years, are still largely dominated by the executive branch and do not change with changes in congressional composition. "The stock market usually does not, nor will it, price in such factors two years in advance," he wrote.
In a scenario where the Republican Party maintains control of the Senate – with a probability of about 24% as indicated by Kalshi – Wilson believes that markets may be forced to look ahead to 2028 in order to assess the risks of resistance to deregulatory policies.
Liquidity supplementation or providing additional support
At the monetary policy level, Wilson made it clear that its judgment framework is not predicated on the Federal Reserve shifting to interest rate cuts or introducing additional easing measures.
On the contrary, he views the decline in the balance of the U.S. Treasury Department's deposit account ( TGA ) as another path to liquidity supplementation. It is expected that the Treasury's cash balance will drop from the current approximately $1.05 trillion to about $850 billion by the end of the year. As government spending is implemented, this portion of funds will flow back into the market, creating a certain liquidity buffer.
Regarding the Russell 2000 small-cap stocks, Wilson takes a relatively cautious attitude, believing that for this index to achieve an effective recovery, the required decline in interest rates is still greater than the extent of reduction that has already occurred. This means that at this stage, he prefers to allocate funds to large-cap high-quality cyclical stocks whose valuations have already been fully corrected, rather than small-cap growth stocks.
