Morgan Stanley chief equity strategist Mike Wilson said in a latest report that U.S. stock indexes remain near record highs, but market internals have become sharply divided. According to Odaily, 51% of Russell 3000 constituents have fallen more than 20% from their June highs, the median S&P 500 stock is 16% below its 52-week high, and market breadth has dropped to its lowest level since the dot-com bubble burst.

Wilson said U.S. Treasury volatility will be key to closing the gap between index levels and market breadth. He noted that the 10-year Treasury yield has risen to 5.25%, the MOVE index has climbed above 100, and the VIX remains below 15.

If bond volatility stays elevated, the S&P 500 could pull back about 6% over the next month to around 7,300 points, Wilson said. If bond volatility eases first, gains in individual stocks could help market breadth catch up with the indexes.

Wilson said the current weakness in the market is mainly reflected in valuation compression rather than a slowdown in corporate earnings, and he currently favors large-cap quality stocks with improving earnings expectations.