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Over the past month, the S&P 500 dropped over 10% from its recent highs, led by a 14% decline in the tech-heavy Nasdaq 100. The recent correction may have been inevitable given rising risks for fiscal stimulus, a potential COVID-19 second wave and the upcoming election. But a resolution to these hurdles may also be possible longer-term, Mike Wilson, Chief Investment Officer and Chief US Equity Strategist for Morgan Stanley reports.

Key quotes

“The correction this month is happening for the same reasons I suspected back in August. First, with Congress embroiled in election-year politics and a disagreement over when to fill the Supreme Court vacancy, the odds of the CARES2 legislation getting passed before November 3rd have dropped considerably. Morgan Stanley public policy strategist Michael Zezas thinks it’s just a 33% chance at this point. Second is COVID-19 and the looming arrival of a second wave. Until we know exactly what it looks like, further lockdowns remain a real possibility. Third, real long-term interest rates appear to have bottomed as the Fed formally tells us asset purchases won’t increase from here. And finally, we have the election itself.”

“The good news is that investors have started to discount these very visible concerns via lower prices and higher financial market volatility. Options markets are pricing in higher risks than normal around the U.S. election, but nothing like we actually experienced in 2016. That doesn’t seem right, given the uncertainty around the election outcome and the process itself. As a result, I expect volatility to remain high for the next 4-6 weeks, creating what is likely to be a difficult trading environment with a wide band for the major averages.”

“Looking beyond the near-term, I think three of the aforementioned risks are likely to be resolved positively by the end of the year, or shortly thereafter. More specifically, additional fiscal stimulus is likely as both parties want to spend more but may not be able to come to terms before the election process is completed. Meanwhile, progress on a vaccine should become clear, and we will eventually have a conclusion to the election. The one risk I think will remain with us is that long-term interest rates are likely to rise further from here, particularly if those other risks fade and the recovery continues.”