Morgan Stanley believes that the short-term volatility in U.S. stocks, triggered by the Federal Reserve's monetary policy and liquidity tightening, presents an opportunity for bullish investors to increase positions.

According to research, as of November 24, Morgan Stanley's team led by Michael J. Wilson noted in a report that while the S&P 500 has only retreated by 5%, two-thirds of the top 1,000 companies by market capitalization have seen declines exceeding 10%, indicating a substantial internal market correction. (Two-thirds of stocks have dropped over 10%.)

The report highlights that U.S. momentum stocks peaked on October 15, coinciding with a significant rise in the U.S. Treasury General Account (TGA) due to the government shutdown. The S&P 500 peaked on October 29, the day of the Federal Reserve meeting, when Chair Jerome Powell stated that a December rate cut was "far from certain."

Morgan Stanley argues that while monetary policy risks may persist in the short term, the major market adjustment is nearing its end. Analysts maintain a bullish outlook for U.S. stocks over the next 12 months, favoring consumer goods, healthcare, financials, industrials, and small-cap stocks.

**Index "Calm," Stocks "Bloodbath"**

The report points out that while the S&P 500's pullback appears modest at around 5%, beneath the surface, the situation is starkly different. Data shows that 66% of the top 1,000 large-cap stocks have experienced deep corrections exceeding 10%. This divergence stems from two key factors:

1. High-momentum stocks are more sensitive to liquidity tightening and peaked after the TGA began rising sharply on October 15. 2. Quality indices like the S&P 500 and Nasdaq 100 reacted more sharply to the Fed's hawkish signals at the October 29 FOMC meeting.

(The S&P 500 rose on the day of the October Fed meeting, but liquidity had already tightened significantly beforehand.)

The report views this broad-based stock correction as a positive sign, suggesting the market adjustment is in its later stages. Analysts even speculate that the final phase could involve a "catch-down" in previously leading mega-cap tech stocks. Meanwhile, this policy-driven correction offers a buying opportunity for investors bullish on a mid-term recovery.

**Fed Uncertainty May Fuel Short-Term Volatility**

The core uncertainty for near-term market movements lies in the Fed's policy path. The report analyzes alternative labor market data through October, showing softening trends but no acceleration. Metrics like ADP employment, Challenger job cuts, unemployment expectations in the University of Michigan survey, and continuing jobless claims all point to further labor market cooling.

(Left chart: ADP job growth slows but doesn’t accelerate; Right chart: Challenger reports show renewed layoffs still well below March highs.)

The delayed September jobs report, released post-shutdown, showed stronger-than-expected payrolls but an unexpected unemployment rate rise to 4.4%, adding to market confusion. Crucially, November jobs data won’t be released until December 16—after the December 10 FOMC meeting—leaving the Fed to decide on rate cuts without the latest labor insights. This information vacuum may prolong near-term volatility. However, Morgan Stanley notes that short-term market weakness could pressure the Fed to act preemptively, reinforcing its mid-term bullish outlook.

**Liquidity Pressures Easing**

High-momentum and speculative growth stocks are particularly sensitive to liquidity constraints. Recent pressure coincided with declining bank reserves, rising TGA balances, and no Fed signal to end quantitative tightening (QT). The widening SOFR-OIS spread reflects tight funding conditions aligned with the TGA surge.

(TGA movements closely track 3-month SOFR-OIS rates.)

However, liquidity improvements should alleviate these pressures. The report predicts the TGA balance will drop sharply post-shutdown before rebounding to ~$850 billion year-end, providing near-term relief. Additionally, the Fed’s QT conclusion on December 1 should boost market liquidity. Key to watch is whether liquidity-sensitive assets (high-beta stocks, speculative growth, crypto, gold) sustain relief in the coming weeks.

**2026 Outlook: Against the Consensus**

Morgan Stanley’s 2026 outlook challenges market consensus on multiple fronts: 1. It sees the market in "early-cycle" vs. the consensus view of "late-cycle." 2. It’s more optimistic on Nasdaq-listed earnings growth, forecasting 17% EPS growth vs. sell-side consensus (14%) and buy-side expectations (sub-14%).

(Nasdaq earnings revisions show upward momentum.)

Most controversially, it upgrades small-caps and consumer discretionary to overweight. After underweighting consumer staples for 3-4 years, the strategists now favor the sector’s early-cycle potential, citing pent-up demand, a goods-over-services shift, lower rates, strong household balance sheets, and extreme pessimism/positioning.

Notably, during recent declines, consumer discretionary, financials, industrials, and small-caps outperformed the S&P 500.

**Morgan Stanley’s 2026 Confidence**

The report stresses that even during the correction, corporate fundamentals remain robust—evidence this is a "policy/liquidity-driven adjustment," not a breakdown. Nasdaq 100’s earnings revision breadth improved last week despite market drops.

Forward 12-month net profit estimates continue rising across major indices, with small-caps leading—aligning with Morgan Stanley’s preference.

(12-month net profit forecasts trend upward, led by small-caps.)

The firm reaffirms its 12-month bullish stance, advising investors to treat further near-term weakness as a buying opportunity, particularly in favored sectors.