Morgan Stanley’s Wilson: Market correction is nearing its end, but the final stage still comes with some pain.

Morgan Stanley signals that the U.S. stock market adjustment is nearing an end, but the final hurdle may not be easy.

On Sunday, April 12, Morgan Stanley's Chief Equity Strategist Mike Wilson stated in his latest weekly report that the current market adjustment is deeper than most investors realize. The S&P 500 is bottoming out, but before issues with interest rates and bond volatility are completely resolved, the market still faces risk of re-testing previous lows.

Wilson believes current market sentiment remains fragile. He explicitly stated, This round of adjustment started in October last year, with S&P 500 forward P/E ratio dropping 18% from its peak — a decline historically seen only during recessions or Fed tightening cycles. "But neither scenario exists in our base case forecast."

Bull Market Adjustment, Not Bear Market

Wilson insists this is "a normal adjustment within the new bull market that began last April after the rolling bottom from 2022 to 2025 recession," not a reversal of trend.

The critical basis lies in earnings. S&P 500 price decline is less than 10%, while more than half the stocks in the Russell 3000 have fallen over 20%. Wilson interprets this as the market having reasonably priced risk, not complacency.

The core data supporting this view: The current median company EPS growth rate has reached double digits, the fastest since 2021.

"The combination of declining multiples and improving earnings is a typical feature of bull market adjustments, not bear markets." Wilson wrote.

He also compared historical oil shock cycles: back then earnings were deteriorating, but currently earnings are still accelerating from a high level, and the rise in oil prices has been relatively moderate in real terms.

Other Risks: Private Credit & AI Disruptions

Wilson directly addressed two other major market concerns.

Regarding private credit, he cited colleague Vishy Tirupattur’s view: “The risks of private credit are substantial, but not systemic.” Private credit has tightened, but most banks have limited direct exposure, which may actually drive business back to traditional lending institutions.

Regarding AI disruption, Wilson believes the narrative is ahead of reality. “Corporate application layers are still in the early stages; in the short term, AI is more likely to support profit margins rather than compress them.” He added that AI gives companies a reason to hold back on hiring, thereby bringing positive operating leverage surprises—one of the reasons for current EPS growth acceleration.

Final Hurdle: Interest Rates and the Federal Reserve

Wilson clearly pointed out that the biggest current market uncertainty comes from interest rates and policy, not geopolitics or credit risk.

Stock-bond correlation has again turned significantly negative, meaning rising interest rates have become a renewed obstacle to valuations. He characterized the central bank’s hawkish turn—mainly driven by commodity inflation expectations—as "the last hurdle the stock market needs to overcome."

Last week's partial market rebound happened simultaneously with Fed Chair Powell adopting a more neutral stance and bond volatility falling.

"The final phase of adjustment is never easy," Wilson wrote, "If rates or bond volatility rise again, the market may need to re-test."

But he emphasized this volatility is part of the bottoming process, not the start of a new bear market. "The market rarely gives investors multiple chances, which is why we encourage early positioning."

Strategic Preference: Barbell Allocation

In terms of specific strategy, Wilson maintains a "barbell" allocation framework:

One side is cyclical stocks with solid earnings and compressed valuations, including financials, industrials, and consumer (durables); the other side is high-quality growth stocks with sentiment and valuations reset to healthy levels, namely hyperscale cloud computing companies.

His final judgment: "Most of the pricing adjustment for geopolitical risk, private credit concerns and AI disruption has been completed. What remains are mainly interest rate and policy issues, which will be resolved as Fed leadership transition is completed."

"The market always moves ahead of the news, and investors should do likewise."

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