Stock market faces 10% correction ahead of U.S. election, warns Morgan Stanley’s chief strategist Mike Wilson, who predicts Q3 will be ‘choppy’

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Investors could face a correction as the quarterly earnings season kicks off, with stocks trading at all-time highs. 

Morgan Stanley’s chief U.S. equity strategist warned uncertainty around a host of different issues—including corporate earnings, the November election outcome, future tariffs and central bank policy—will mean the current third quarter could get “choppy” for investors.

“Right here, valuations to me look very, very unexciting,” Mike Wilson told Bloomberg TV on Monday. “I think the chance of a 10% correction is highly likely sometime between now and the election.” 

The Morgan Stanley strategist was quick to point out that apart from a few dozen U.S. corporations, the average company isn’t seeing its profits increase, and it will not until the Federal Reserve begins to loosen. 

Investors are hoping to glean some helpful hints on the direction of monetary policy when chair Jay Powell provides testimony to Congress today and tomorrow. Currently the market is pricing in an 80% chance of a rate cut in September as labor market data softens. 

“We need rates to come down, that’s number one,” Wilson told Bloomberg Television. “Or we need some sort of exogenous positive shock on the growth side that doesn’t lead to an inflationary problem. You tell me where that’s coming from.”

AI chip supplier Taiwan seeing exports to U.S. soar

Here’s where artificial intelligence, and generative AI in particular, enters the picture.

Whether it’s Apple, Meta, or Amazon, many companies are notching fresh record highs amid expectations that AI will prove transformational for corporate profits, boosting productivity without pushing up prices.

The question is whether the slate of earnings figures will bear that out when the first begin reporting results later this week, starting with the major Wall Street banks on Friday.

“I am looking at during the second quarter for a lot of companies to give us some specific examples of how AI is starting to make a difference in their productivity and cost cutting,” Yardeni Research president Ed Yardeni told CNBC on Monday.

The latest export data from Taiwan, a major provider of cutting-edge electronics needed for AI-powered data centers, shows goods shipped to the United States soared 74% in June over the previous year’s period, helped by companies like Taiwan Semiconductor Manufacturing Company

On Monday, the country’s industry-leading foundry, which fabricates AI chips on behalf of Nvidia, even joined, however brief, the elite club of megacap stocks worth $1 trillion or more.

In the face of this momentum, Yardeni believes investors find little reason not to chase the market higher.

“The market for the past few weeks has just continued to march higher to new record highs and it’s done it on disappointing economic indicators,” he said.

“I think investors have concluded that let’s not worry too much about the economy slowing or even a recession because if that were even to become a significant risk, the Fed will move pretty quickly to lower interest rates.”

AI hallucinations may erode some of the predicted productivity gains

But AI may not prove to be the silver bullet everyone thinks.

James Ferguson, founding partner of UK-based economic research firm MacroStrategy Partnership, argues investors are not accounting for the propensity of generative AI to hallucinate, i.e. spit out fictitious data and information that dilutes productivity gains.

Businesses that fail to spend time double-checking their work can find themselves in a similar bind as the law firm Levidow, Levidow & Oberman.

It made headlines across the country in all the wrong ways after submitting a legal argument that cited case precedents ChatGPT had fabricated out of thin air.

“Fake it till you make it may work in Silicon Valley, but for the rest of us, I think once bitten twice shy may be more appropriate,” he told a recent Bloomberg podcast, warning the hype around AI has spawned a concentrated market bubble reminiscent of the dotcom era. “If AI cannot be trusted […] then AI is effectively—in my mind—useless.”

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