I think we can all agree it’s been a wild year for stocks.

The unprecedented locking down of most of the world’s economy in early 2020 resulted in the fastest bear market in history, a stunning 34% decline in the S&P 500. While a 34% bear market is hardly unprecedented, it’s actually about average for bear markets since 1945, those declines normally take 12 months, and this one took just one. That was, of course, followed by the sharpest bear market rally in history, triggered by record stimulus from Congress and the Fed, as well as a stronger than expected economic rebound as states reopened. But alas, the pandemic that started this wild market ride, is back with a vengeance. And now Morgan Stanley, one of the 16 most accurate economic teams in the world, is out with a potentially frightening prophecy, right in time for Halloween.

Let’s take a look at why one of the most respected economists and asset managers now thinks another stock market correction is not just possible, but the most likely outcome. More importantly, discover the most effective ways to not just protect your portfolio from the likely coming market pain, but actually how to profit from it when the bulls finally start charging down Wall Street once more.

Morgan Stanley Thinks a Correction Is Coming Soon

“The S&P 500 is likely to see a 10% correction in the near term before the bull market continues, according to Morgan Stanley’s chief investment officer.

“With so many uncertainties over the next month, we think another 10% correction from Monday’s highs is the most likely outcome in the near term before this bull market can resume,” Mike Wilson, also Morgan Stanley’s chief US equity strategist, wrote in a Monday note.

The benchmark index saw its first 10% correction in the new bull market in September — after breaking 3,500, it quickly retreated, Wilson said. Last week, the S&P 500 attempted to break through 3,550 but failed, a sign that the correction that began in September is not over, he said.” – Business Insider (emphasis added)

While no economist or asset management team has a crystal ball, Morgan Stanley is among the 16 most accurate economist teams in the world, and so it’s well worth considering the warning about high short-term volatility that Mr. Wilson is warning about. What kind of uncertainty is likely to drive stocks down 10% from here, to about a 12% total decline from September 12th lows?

Wilson added that the lack of a fiscal stimulus deal, uncertainty about the outcome and timing of the election, and another wave of coronavirus cases were headwinds to higher stock prices in the near term. Going into any pullbacks, investors should look to reallocate their portfolios toward stocks that will benefit from the reopening of the economy, the investment chief said.” – Business Insider (emphasis added)

The Pandemic Is Ramping Up Again

US virus cases have been surging in the last few weeks, exactly as leading health experts had warned was likely. The 7-day average is 70,000 daily cases, and on October 23rd we hit 85,000, smashing the previous record of 72,000 set back in mid-July. What’s causing the third wave of the virus in the US? According to Dr. Michael Osterholm, director of the Centers for Infectious Disease Research & Policy (CIDRAP) at the University of Minnesota, the same factors that are causing the global third wave

• states eased restrictions
• individuals became tired of following social distancing
• more people spend times indoors, in large gatherings
• lower humidity air during the fall/winter (virus travels further due to smaller droplets that don’t fall to the ground as fast)

The Institute for Health Metrics & Evaluation or IHME at the University of Washington expects that the third wave will peak in terms of new daily cases around the end of the year. Daily deaths are expected to peak two to three weeks later. How bad could things get? Dr. Anthony Fauci told the Senate back in July that he wouldn’t be surprised to see 100,000 + daily cases in the US were an estimated 10% of the population has been infected so far. It takes 60% to 70% immunity to slow the spread of the virus so America has plenty of kindling left for the corona fire to continue burning red hot for several months.

Election Uncertainty Could Be Historic

Moody’s most recent internal election model estimates that Biden is likely to win the election but in a close race.

It takes 270 electoral votes to win and assuming that turnaround is average, Moody’s estimates that Biden is likely to barely edge out Trump in a close race that might not be decided for a week, as mail-in votes trickle in. In this scenario, President Trump is expected to sue in several swing states, and a contested election could be decided by the Supreme Court, to which Trump has now appointed four justices. The last time the Supreme court decided the election was in 2000 and that was a five-week process that saw the stock market fall 8% at one point. Back then the economy was growing at 5.4%, and America was a lot less polarized.

Today Moody’s warns that:

The nation feels like it could boil over if Trump versus Biden is a close election and one side or the other believes that the election is being stolen.”

Moody’s is another blue-chip economist and when they warn that violence following the election is a real possibility, and the economy could suffer as a result of a contested election, it’s prudent to pay attention.

Stimulus Uncertainty Continues to Weight On Wall Street

Deutsche Bank estimates that with a $2 trillion stimulus package passed in early 2021 the economy would recover all the lost output the pandemic has caused, by late 2021.

(Source: Jeff Miller)

That’s the good news. The bad news is that if we don’t get any new stimulus then we’ll never recover that lost output and it will take several years for the labor market to recover full employment.

According to a September survey of economists conducted by the Chicago Booth School of Management, whether or not we get stimulus will largely depend on the election outcome. Specifically, how control of the Congress and the White House looks. The status quo, meaning a Trump win, with no change in control of the House or Senate, would lead to ongoing gridlock that is viewed as the 3rd most negative economic scenario according to the majority of economists. In other words, there is a lot that could go wrong right now, with the pandemic, the election, and with the stimulus in 2021. All of this is why Morgan Stanley’s prediction of another 10% decline in the stock market seems rather reasonable.

(Source: JPMorgan Asset Management)

JPMorgan, another blue-chip economist team, believes that if the third wave is bad enough then the S&P 500 might plunge not 12% before bottoming, but 22%. That would be the first time in US market history we’ve had two bear markets in one year. While that’s not JPMorgan’s base case scenario, 2020 is a year of unprecedented historical first. In part two of this series, I’ll show you how to protect your portfolio from what Morgan Stanley believes to be the likely short-term correction. Most importantly I’ll show you how to profit from the coming market fear, to lock in potentially amazing gains in 2021 and far beyond.

Want More Great Investing Ideas?

Top 11 Picks for Today’s Market

Dangerous Outlook for Stocks Into Election

5 WINNING Stocks Chart Patterns

SPY shares were trading at $327.98 per share on Wednesday morning, down $10.24 (-3.03%). Year-to-date, SPY has gained 3.36%, versus a % rise in the benchmark S&P 500 index during the same period.

About the Author: Adam Galas

Adam has spent years as a writer for The Motley Fool, Simply Safe Dividends, Seeking Alpha, and Dividend Sensei. His goal is to help people learn how to harness the power of dividend growth investing. Learn more about Adam’s background, along with links to his most recent articles. More...

More Resources for the Stocks in this Article