Strategist who accurately predicted the sharp drop in US stocks in August: Non-farm data may support market recovery

Morgan Stanley strategist who successfully predicted the U.S. stock market correction last month said that if the data released on Friday further proves the economy's resilience, lagging sectors in the market may receive a boost.

Michael Wilson, Chief U.S. Stock Strategist at Morgan Stanley, wrote in a research report that stronger-than-expected employment data could make investors "more confident that growth risks have receded".

Economists surveyed by Bloomberg expect the report to show that the U.S. economy created 165,000 jobs last month, up from 114,000 in July.

Technology stocks have largely driven the surge in the S&P 500 index (SPX) this year, with other sectors still having a long way to catch up. In recent weeks, concerns about overvalued tech stocks have led to a shift in this trend, prompting investors to enter other sectors of the market. According to data compiled by Bloomberg, about 16% of stocks in the index are currently at 52-week highs, compared to 4% at the beginning of the year.

Breadth of the U.S. stock market is expanding

Wilson reiterated his preference for defensive stocks, while warning against buying small-cap stocks or "other cheap cyclical stocks that have underperformed in recent years, mainly because he expects growth to continue to slow".

Wilson had warned in early July that traders should be prepared for a significant market pullback amid uncertainties surrounding the U.S. election, corporate earnings, and Fed policy. Less than a month later, the S&P 500 index fell 8.5% from its peak. Wilson had also predicted a market decline last year, which did not materialize.

Strong economic data since the sell-off in August has driven the recovery in U.S. stocks, and Wilson expects this week's employment report to also support this trend. On the other hand, he wrote that weaker-than-expected job growth coupled with a rise in the unemployment rate will "put pressure on stock valuations as it did last month".

Wilson added that the "sweet spot" for the stock market would be the Fed's consecutive 25-basis-point rate cuts and the economy maintaining stable growth. "In contrast, if the data shows weakness in the labor market and a more moderate policy response (i.e. a 50-basis-point rate cut), the market's reaction may not be positive."

Wilson warned that one "challenge" facing investors is that U.S. stocks are already pricing in a soft landing, limiting the upside potential of stock indices. He said that if the data reignites concerns about a hard landing, this could trigger a "substantial" decline.

The strategist expects the S&P 500 index to reach 5400 points by mid-2025, implying a drop of about 4% from current levels