The stock market may be headed toward a major pullback as some economic indicators have started to deteriorate, according to Morgan Stanley. Chief U.S. equity strategist Mike Wilson said in a note to clients that the market is at a fork in the road of "fire" and "ice" directions, and it appears to be starting down the negative path. "The 'ice' scenario is starting to look more likely, and could result in a more destructive outcome — i.e. a 20%+ correction," the note said. Stock futures were sliding Monday morning as the Dow Jones Industrial Average was coming off three-straight losing weeks. The softness for the market comes as Wall Street has had an abnormally long gap of not seeing a pullback of at least 5%. Factors that could extend the market's decline include downward earnings revisions, weak consumer confidence and poor readings from purchasing managers indexes, Morgan Stanley said. The end of the major pandemic relief programs could make the transition back to a more normalized economy rougher than many expect, according to Wilson. "Given the extraordinary fiscal stimulus during this recession, we are concerned that the inevitable deceleration in growth will be much worse than what is currently expected. This is the 'ice' scenario and would likely lead to a larger than normal mid-cycle transition correction in the S & P 500—i.e.20%," the note said. Wilson has a year-end target of 4,000 for the S & P 500, which is nearly 10% below where the stock closed on Friday. He said the market will see a "rolling correction" as it transitions out of the economic rebound period that defined the spring and summer. Morgan Stanley has an underweight rating on the economic-dependent consumer discretionary sector and recommends some of the more defensive plays. "We continue to recommend a barbell of more defensively oriented quality (Healthcare and Staples) to protect from the 'ice' scenario while keeping a leg in Financials to participate in the 'fire' outcome as higher rates materialize," the note said. -CNBC's Michael Bloom contributed to this report.
Bull and bear sculptures in front of the German stock exchange in Frankfurt, Germany.
Kai Pfaffenbac | Reuters
The stock market may be headed toward a major pullback as some economic indicators have started to deteriorate, according to Morgan Stanley.