Stocks are likely to see a 10% correction as earnings weaken and election uncertainty swirls, Morgan Stanley CIO says

• Stocks are likely to drop around 10% between now and the November election, Morgan Stanley predicted.
• That's because corporate earnings look weak and need several catalysts to improve, the bank's Mike Wilson said.

Stocks are poised to see a double-digit drop, according to Morgan Stanley's Mike Wilson.

The bank's CIO and chief US equity strategist warned of a looming correction in the stock market, largely thanks to a rocky outlook for corporate earnings and the economy leading up to the presidential election.

"If you have bad earnings reports, you're going to get punished. That's been consistent all year, which is why the average stock is down this year," Wilson said in an interview with Bloomberg on Monday.

While the S&P 500 has hit a series of record highs this year, the benchmark index is largely being propped up by a handful of growth stocks, which have seen outsized returns amid the investor frenzy for all things related to artificial intelligence.

The weak outlook for earnings is also exacerbated by the fact that inflation is slowing, which is eating into corporate profits as companies' pricing power wanes, Wilson said.

"The average company does not have good earnings results," he added.

Stocks need a number of things to change the market rally is to continue, Wilson said, pointing to various obstacles, like high interest rates and tightness in the labor market.

Those obstacles are typically cleared once the economy enters a new business cycle, Wilson added, noting that the small-cap Russell 2000 index typically sees outsized returns after the economy goes through a recession. Until then, investors run the risk of a sharp downside to equities, he suggested.

"What worries me is that that momentum is so strong … and if you have an event that's unpredictable then you can have a real reset on valuations of 10%-15%, Wilson said of stocks. "I think the chance of a 10% correction is highly likely between now and the election."

Other forecasters have flagged the risk of a near-term stock correction, given how high valuations are. Prominent bears like John Hussman and fund manager Mark Spitznagel have sounded the alarm for a double-digit stock crash, pointing to similarities between today's market and previous market bubbles.