‘A credit crunch has started’ as banks tighten lending by the most on record, Morgan Stanley CIO says

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The credit crunch stemming from the fallout of Silicon Valley Bank has begun, with data showing clear tightening of lending standards by banks, according to Morgan Stanley’s top stock strategist Mike Wilson.

In a note on Sunday, the Morgan Stanley CIO said that the last two weeks have shown the steepest decline in lending on record as banks scramble to offset the breakneck pace of deposit flight, which has accelerated in the month since SVB failed.

“The data suggest a credit crunch has started,” Wilson said in the note, adding that $1 trillion in deposits has been withdrawn from US banks since the Federal Reserve began raising rates a year ago.

Further illustrating the credit crunch is the most recent small business lending survey, which last week showed that credit availability has seen its largest drop in 20 years, coming alongside the highest interest rates seen in 15 years.

That’s worrisome for the US economy and markets, which have already been squeezed since the Fed embarked on an aggressive campaign to raise interest rates and bring down inflation.

Tighter financial conditions could raise the risk that the economy falls into a recession this year, as both companies and households experience difficulty obtaining credit.

The spate of bank failures and the ensuing credit crunch fuel Wilson’s view that stocks are in trouble this year.

Previously, Wilson forecasted as much as a 20% drop in the S&P 500 in 2023 as corporate earnings drop, with the worst earnings recession since the 2008 recession potentially on tap this year.

He notes that major indexes holding steady since the SVB episode should not be taken as a sign that everything is fine, but rather an indicator that stocks are at risk of a sudden drop similar to what has been seen in small caps and bank stocks since March.

“To those investors cheering the softer-than-expected inflation data last week, we would say be careful what you wish for,” Wilson said, pointing to the March Consumer Price Index report, which showed inflation climbing less than expected. “If/when revenues begin to disappoint, that margin degradation can be much more sudden, and that’s when the market can suddenly get in front of the earnings decline we are forecasting,” he added.