Morgan Stanley: 'One last surge of euphoria' will take market up more than 10% from here

Key Points
  • "We believe this vol shock/liquidity event has likely taken valuations too low at this point," says Morgan Stanley's Michael Wilson.
  • The Dow, S&P 500 and Nasdaq posted their worst weekly performances since early 2016 last week.
  • But Wilson notes his firm's bullish S&P 500 target of 3,000 is still achievable despite the pullback.
Elif Ozturk | Anadolu Agency | Getty Images

A Morgan Stanley strategist thinks equities can surge more than 14 percent from current levels despite their recent sharp pullback.

Michael Wilson, chief U.S. equity strategist at the firm, said in a note Monday that the S&P 500 could reach his "bull case" target of 3,000 "by the middle of the year as investors bid up P/Es toward 18.5x on one last surge of euphoria before settling back down by year end."

Wilson's bull target is about 14.5 percent above where the S&P 500 closed Friday. The broad index finished Friday's session at 2,619.55.

The Dow Jones industrial average and both pulled back 5.2 percent last week, notching their worst weekly declines since January 2016. The Nasdaq composite, meanwhile, dropped 5.1 percent, marking its biggest one-week retreat since February 2016. The indexes also dipped into correction territory.

Some traders attributed the recent decline to inflation fears pushing interest rates higher and sharp moves in obscure volatility funds that use leverage.

"We believe this vol shock/liquidity event has likely taken valuations too low at this point but realize such events have a way of overshooting to the downside which is why we have advocated patience in buying this dip," Wilson said.

However, Wilson warned clients that volatility was unlikely to return to the subdued levels seen in 2017.

"While we believe most of the price damage is over for this correction, we do not think we are going to return to the same level of low volatility of the recent past," he said.

"This is typical of a late cycle expansion which is another reason why multiples will be lower as higher volatility typically demands a higher equity risk premium. As a result, we do not expect a quick return to the prior highs although we do think higher highs for the S&P 500 are likely ahead of us before the cycle top later this year."