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How Congress could start that stock market pullback everyone's been waiting for

  • Stocks dodged a major summer sell-off, but they could still see a pullback of 5 to 6 percent, according to Morgan Stanley chief equity strategist Mike Wilson.
  • The pullback could be triggered by congressional wrangling over the details of tax legislation expected to be unveiled Wednesday but with few details.
  • Wilson's target is 2,700 for the S&P 500 by early next year.

Stocks dodged a summer swoon, but Morgan Stanley's Mike Wilson says the market may see an autumn pullback of about 5 to 6 percent.

The catalyst may very well be the tax reform debate, particularly if Congress does not look like it is in agreement on main elements. But stocks should resume their climb after the sell-off, and the S&P 500 could ultimately reach his 2,700 target early next year, especially if stimulus and tax reform are approved.

Wilson, whose target is the highest in CNBC's strategist survey, says the market could then have a much more serious correction — potentially sliding 20 percent. "We'll get to 2,700 first, and then the timing of the beginning of the cyclical bear could be imminent. It could be anytime after that. It could be as early as the second half of next year," he said.

The S&P 500 closed at 2,496 Tuesday, a decline of 0.2 points.

Wilson, Morgan Stanley's chief equities strategist, said if the stock market does have a pullback this year, it could be in late October, early November. That could coincide with congressional efforts to "try to figure out the details" of tax legislation. He said the details "are going to be sparse" when the much-anticipated plan for individual and corporate tax cuts is announced Wednesday.

The Trump administration and GOP congressional leaders have been working out a plan that now goes to the House to hash out details. President Donald Trump will discuss tax cuts and tax reform in Indianapolis Wednesday.

"I think the way it sets up is people probably get excited over the next couple of weeks," said Wilson, also chief investment officer, institutional securities and wealth management. Wilson expects earnings will be good, and they should keep buoying the market. "Then we're going to have the inevitable disappointment."

But there's another trend he says could lift the market this fall. Both retail and institutional investors, who have been waiting for a correction, still have cash to put to work, and they could start to do that in the next couple of weeks.

Wilson also said the sell-off in tech Monday was not a concern, and he expects earnings to be good. "The area that's most vulnerable is internet software space. Not because of fundamentals. It's because they're over-owned. It's a rotation. I think tech will get a bid going into earnings season," he said.

Wilson downgraded consumer discretionary to underweight this week.

"It's more about end of cycle. Our view is we're late cycle. We were never really bullish on consumer discretionary this year," he said. He does like energy, tech, financials and industrials, and he said the next phase of the reflation trade is taking hold after consolidation.

He also said the reflation trade, lifting small-caps, energy and banks recently, is a positive. The trade, called "Trump trade" by some, fizzled after a strong push higher in those groups just after the election last year.

"It is really more about Congress. … I call it the pro-growth agenda," he said.