A rally in the S&P 500 in the fourth quarter of 2023 "is more likely than not", Morgan Stanley's Michael Wilson said in a note.

Wilson and other strategists said a majority of investors believed in a potential rally if current levels hold in the short run, despite lingering concerns around higher interest rates and slowing economic growth.

"Many are still leaning more long than they would like, to reduce the probability of missing out in a year in which narrow megacap strength has driven benchmarks," they said, even as the confidence level may have waned a bit in the past week.

Morgan Stanley maintains its 3,900 year-end price target for the S&P 500 and believes the best way to position is a barbell of defensive growth stocks that have stable earnings, and late-cycle cyclical stocks such as energy.

Wilson, one of the most bearish voices of Wall Street, said the positive sentiment in the market was contingent on current stock prices holding in the short term.

"If it does not, we could see positioning quickly shift to locking in profits and/or relative performance into year end," said Wilson, Morgan Stanley's chief U.S. equity strategist.

The S&P 500 has rallied about 13% this year, boosted by the AI euphoria and expectations that the U.S. central bank will not raise interest rates further, but recent economic data and Fedspeak have turned the sentiment in the last one month.

Stocks came under selling pressure last week as investors rushed to Treasuries after a surprise attack by militant group Hamas against Israel, but S&P 500 still managed to eke out some gains.

"The fact that stocks rallied early in the week emboldened the view that equity markets could withstand another exogenous shock," Wilson said.

(Reporting by Shubham Batra in Bengaluru)