The stock market is set for a 10% correction before the US economic recovery sparks a bounce-back at the end of 2020, Morgan Stanley says

• Morgan Stanley analysts said stocks are set for a 10% correction in the coming months after the huge gains seen since the early days of the coronavirus pandemic.
• "We think the most likely outcome remains a 10% correction in the broader index led by the beneficiaries before the recovery and bull market continues," analysts led by Michael Wilson wrote on Monday.
• They said they expected the economy to have a "surprising recovery" later in the year and through 2021 when markets could bounce back.
• Wilson and his team also suggested a way for investors to capitalize on a slide in stocks and warned of the threat of rising inflation in the US.

Stocks will fall 10% before a "surprising recovery" later in the year and into 2021 pushes markets back up, Morgan Stanley analysts said this week.

Analysts led by Michael Wilson said in a research note Monday that surging coronavirus cases and uncertainty about the US presidential election were factors that would likely push stocks lower in the coming months.

"We think the most likely outcome remains a 10% correction in the broader index led by the beneficiaries before the recovery and bull market continues," Wilson and his colleagues Adam Virgadamo, Andrew Pauker, and Michelle Weaver said.

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Stocks have continued to gain this year, and tech stocks in particular have soared during the pandemic. The Nasdaq is up 27% since the start of the year, while Apple's stock is up almost 50% and Amazon has risen 70%.

But the US bank thinks that tech stocks will fail to escape the wrath of uncertainty and a correction but will ultimately bounce back.

"Once the correction is complete we expect the bull market to continue to broaden out and based on what we think will continue to be a surprising recovery in the economy and earnings later this year and into 2021," the analysts wrote.

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Morgan Stanley's prediction is likely to reassure some investors, as many in markets fear that a weak US economic recovery (GDP contracted 33% in the second quarter) could push stocks lower in the longer term.

Morgan Stanley is one of the few banks still expecting a V-shaped recovery.

The US banking giant also said that stock markets were being overly bearish in their expectations of second-quarter earnings. Morgan Stanley said markets were pricing in sales and earnings down 10% to 36%.

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"However, upside surprise in S&P 500 earnings this quarter is one for the record books at 22%, vs a normal range of 4-6%, driven by a mix of better than expected sales and aggressive cost cutting to protect margins," the analysts said.

They added: "This is very much in line with our V-shaped recovery for the economy and earnings. It's also supportive for our call for a rotation to the biggest laggards of the pandemic because those revisions have the most potential upside over the next 6-12 months."

Wilson and his team also suggested a way for investors to capitalize on a slide in stocks and warned of the threat of rising inflation in the US.

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