Morgan Stanley: Two-thirds of large-cap stocks have already pulled back by nearly 10%; the correction in US stocks is "nearing its end."
Morgan Stanley believes that short-term volatility in U.S. stocks caused by Fed monetary policy and liquidity tightening actually provides an opportunity for bulls to increase their positions.
According to Chase The Wind Trading Desk, on November 24th, Morgan Stanley's Michael J Wilson research team pointed out in their latest report that although the S&P 500 Index only pulled back 5% at the index level, two-thirds of the top 1,000 companies by market capitalization have seen declines of more than 10%, showing that internal market adjustments have been fairly thorough.
(Two-thirds of stocks have fallen by more than 10%)
The research report indicates that U.S. momentum stocks peaked on October 15th, when the Treasury's TGA account increased significantly due to a U.S. government shutdown. The S&P 500 peaked on October 29th, the day of the Fed meeting, during which Powell said a December rate cut was "far from a done deal."
Morgan Stanley believes that while risks related to monetary policy may persist in the short term, the major adjustment in U.S. stocks is nearing its end. Analysts maintain a bullish outlook for U.S. stocks over the next 12 months, with recommendations focusing on consumer goods, healthcare, financials, industrial sectors, and small caps.
Index "Calm On The Surface," Individual Stocks "Blood in the Streets"
Morgan Stanley points out that U.S. equity markets have recently appeared calm on the surface, with the S&P 500 Index only pulling back by about 5%. However, the scene beneath the surface is quite different.
Data shows that among the top 1,000 companies by market capitalization, as many as two-thirds (66%) of stocks have experienced deep pullbacks of more than 10%. This divergence has two main causes:
First, high-momentum stocks are more sensitive to liquidity tightening, having peaked after a significant increase in the U.S. Treasury General Account (TGA) starting October 15th;Second, high-quality indices, represented by the S&P 500 and Nasdaq 100, reacted more sharply to the hawkish signals sent by the Fed at the October 29th FOMC meeting.
(Standard indices fell on the day of the October Fed meeting, but liquidity was already tightening before then)
The research report sees this extensive and deep stock-level adjustment as a positive sign, suggesting that the market correction is past the halfway point.
Analysts even think that the final stage of this correction may be a "catch-down" in the large-cap tech stocks that led the previous rally. This monetary policy-driven pullback provides a good opportunity for investors bullish on a mid-term recovery to add to positions.
Fed’s Moves Uncertain, Short-Term Volatility May Intensify
The key uncertainty in short-term market trends lies in the Fed’s policy path.
The report analyzes various "alternative" labor market data as of late October and finds many indicators are showing weakness, but not an accelerating trend.
ADP employment data, Challenger layoff announcements, unemployment expectations in the University of Michigan Consumer Sentiment Survey, Chicago Fed model implied unemployment rate, WARN layoff notices, and continuing jobless claims all show further labor market cooling.
(Left: ADP job growth slows, but not at an accelerating pace; Right: Challenger report shows layoffs intensifying again but still well below the March peak)
Previously, due to the U.S. government shutdown, the official September employment data was delayed, showing job creation above expectations but an unexpected rise in the unemployment rate to 4.4%, increasing market confusion.
More importantly, the official November employment data will be released on December 16th, after the December 10th FOMC meeting. This means the Fed will have to decide on a December rate cut without access to the latest labor market data.
This information gap could lead to continued short-term price swings. However, Morgan Stanley points out that short-term weakness in stocks or funding markets could actually increase the chance of Fed "pre-emptive action," thus strengthening the mid-term structural bullish outlook.
Liquidity Constraints Are Easing
Morgan Stanley points out that high-momentum and speculative growth stocks are most sensitive to liquidity constraints.
When bank reserves fall, TGA balances rise, and the Fed has not yet announced an end to quantitative tightening (QT), markets face short-term pressure. The widening of the SOFR-OIS spread reflects recent tight funding conditions, which coincided with the rise in TGA.
(TGA account and 3-month SOFR-OIS rate moves are highly correlated)
However, as liquidity improves, these pressures are expected to ease.
The research report predicts that with the end of the U.S. government shutdown, the TGA balance will drop sharply in the coming weeks and then rebound to about $850 billion at year-end, which should boost liquidity conditions in the short term.
Additionally, the Fed is set to end balance sheet reduction on December 1st, which will also help inject liquidity into the markets.
Morgan Stanley believes the key indicator to watch is whether the most liquidity-sensitive asset classes in the next two weeks (high beta and speculative growth stocks, crypto, gold) will see continued relief.
2026 Outlook: Standing Against Market Consensus
Morgan Stanley’s latest 2026 outlook contains several views that differ from market consensus.
First, the firm sees the market as being in the "early cycle," while consensus sees a "late cycle" phase.
Second, it is optimistic about earnings growth for Nasdaq-related companies. The report projects 17% earnings per share growth in 2026, while bottom-up sell-side consensus expects 14% and buy-side consensus is below 14%.
(Earnings forecasts for Nasdaq index-related companies have been revised higher)
Perhaps most controversially, Morgan Stanley has upgraded small caps and consumer discretionary stocks to "overweight."
The strategy team says that after years of underweighting consumer stocks, the sector now looks promising in early-cycle conditions.
The report emphasizes that pent-up demand, a shift in consumption from services to goods, falling interest rates, strong household balance sheets, and deeply depressed market sentiment/positioning all suggest the sector will outperform the broader market.
In fact, in the recent U.S. market decline, consumer discretionary, financials, industrials, and small caps have outperformed the S&P 500.
Morgan Stanley Is Confident About 2026
The report highlights that even during a U.S. stock market pullback, company fundamentals remain strong. This is solid evidence that the current downturn is simply a "policy- and liquidity-driven adjustment," not a fundamental collapse.
Thanks to solid fundamentals, breadth of earnings revisions in the Nasdaq 100 Index actually rose last week.
Data shows that for all major indices, net profit forecasts for the next 12 months remain on an upward trajectory, with small caps growing most strongly—consistent with Morgan Stanley’s bullish view on small caps.
(12-month net profit forecasts continue to rise, with the strongest momentum in small cap stocks)
Morgan Stanley says it is confident in its bullish view on U.S. stocks over the next 12 months, and advises investors to treat any further short-term weakness as an opportunity to add to favored sectors.
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The above content is from Chase The Wind Trading Desk.
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