Morgan Stanley and Goldman Sachs both speak out: Beware of a third-quarter pullback in US stocks!

As uncertainty surrounding the U.S. presidential election, corporate earnings, and Fed policy increases, both Morgan Stanley and Goldman Sachs issued warnings on Monday, believing that there is a high risk of a recent pullback in U.S. stocks, and traders should be prepared.

Morgan Stanley: "Will Be Very Volatile" in the Third Quarter

Mike Wilson, chief U.S. equity strategist at Morgan Stanley, stated in a media interview on Monday: "I think the probability of a 10% correction between now and the election is very high." He believes that the third quarter "will be very volatile."

The S&P 500 index hit a record high at the opening of this week, and if it closes positively on Monday, it will mark the 35th closing record high of the year. With market expectations of two rate cuts by the Fed this year and the AI boom still ongoing, the S&P 500 index has risen 17% this year after a 24% increase in 2023.

Over the past two years, long-term bears like Wilson have been forced to moderate their tone. However, as the third quarter approaches, more and more Wall Street professionals are becoming cautious. Analysts believe that the third quarter is a period of high seasonal volatility, especially as signs of overheating in the uptrend emerge.

Wilson said, "The probability of an increase from now until the end of the year is very low, much lower than normal levels." He believes that the chances of U.S. stocks ending the year higher than current levels are 20% to 25%.

However, Wilson is not particularly concerned about a pullback. Instead, he suggests that this may provide buying opportunities for investors, as the double-digit gains in the S&P 500 index this year have made valuations "not exciting." Currently, the best way to invest in the stock market is through individual stocks rather than indices, he said.

Wilson and his team continue to recommend high-quality growth stocks, as well as stocks with overall high quality, such as large-cap stocks, companies with strong balance sheets, and those that can generate returns. He believes that the momentum of such stocks will continue, but the challenge is to find cheap stocks in these categories, he said. Therefore, "if they fall 10%, we may be interested again."

Goldman Sachs: Buyers Exhausted, August First Two Weeks Most Dangerous

Scott Rubner, Managing Director and Tactical Expert of the Global Markets Division at Goldman Sachs, also expressed similar views. He stated on Monday that if corporate earnings disappoint, he expects a painful two weeks for U.S. stocks starting in August, as outflows of passive investor funds and any disappointment in corporate earnings could force funds to sell stocks.

Data shows that in the first half of 2024, inflows into U.S. stock ETFs and mutual funds reached the second-highest record at $231 billion, but August is typically the worst month for stock flows. Rubner wrote in a report to clients that with funds already deployed for the third quarter, there are no predicted inflows in August

"Buyers have run out of ammunition, I am watching the outflow of funds."

Historical data shows that the US and global stock markets usually experience fund outflows on the eve of US elections, followed by a resumption of fund inflows in November. Hedge funds typically have low net exposures before elections. Since 1928, July 17th has usually been a local high before entering August, with the first half of August being the fifth worst two-week period of the year. Data shows that since 1983, the Russell 2000 Index has its second worst two weeks in the first half of August.

Rubina also mentioned that the threshold for second-quarter earnings is no longer a tailwind factor as high expectations have already been priced in. With the increase in systematic fund positions, any surge in volatility and underperformance of "highly held market cap weighted stocks" may force non-fundamental sellers to reduce risks.

After the S&P 500 Index set 34 historical highs, Rubina stated, "I am actually turning tactically bearish. The painful trade has shifted from upside to downside."

In addition, Andrew Tyler from the trading department of JPMorgan Chase & Co. mentioned that he has "slightly less confidence" in the bullish outlook following recent weak economic data. Scott Chronert from Citigroup Inc. also warned of a possible pullback