Investors think a systemic credit event has replaced high inflation as the number one risk to the stock market

• Investors say the biggest risk facing the stock market is no longer inflation, but a systemic credit event.
• The shift in Bank of America's Fund Manager Survey comes after the collapse of Silicon Valley Bank.
• "Investor sentiment close to levels of pessimism seen at lows of past 20 years," BofA said.

All it took was the second largest bank failure in US history to shift investors' focus away from elevated inflation and towards a systemic credit event.

That's according to Bank of America's Fund Manager Survey, which for the first time since early 2022 showed that concerns of high inflation and hawkish central banks did not dominate the "biggest tail risk" concerns among survey participants.

Instead, the survey, which includes hundreds of professional investors that manage more than $500 billion in assets, highlighted that the downfall of Silicon Valley Bank, Signature Bank, Credit Suisse, and the precarious position of First Republic Bank, has sparked a wave of pessimism among investors.

"Investor sentiment [is] close to levels of pessimism seen at lows of [the] past 20 years," Bank of America's Michael Hartnett said. Participants in the survey said they have dumped their exposure to bank stocks on fears of credit and counterparty risk and increased their allocation to cash in recent days.

The portfolio allocation to cash hit 5.5%, which is historically elevated but below the October 2022 "close-your-eyes-and-buy" level of 6.3%, according to the survey.

The elevated level of bearishness among investors, combined with the Federal Reserve and US Treasury's swift response to the banking crisis suggests to Hartnett that the S&P 500's 3,800 level will serve as a "floor" that holds. At the same time, Hartnett recommends investors fade any rally that sends the S&P 500 to the 4,100 to 4,200 range. The S&P 500 jumped 1% to 3,992 in Tuesday's trading session.

While bank risks are the top concern to investors currently, inflation remains a close second, according to the survey, as does the potential for the economy to enter a low growth and high inflation period, also known as stagflation.

Just under 90% of survey respondents expect the US economy to be dealing with stagflation through the first quarter of 2024. The banking crisis could add credence to those concerns if banks tighten lending standards, which would ultimately result in slower economic growth.

"Expectations for stagflation have remained above 80% for 10 months in a row... FMS investors have never held such strong conviction about the economic outlook," Hartnett said.

Investors will get a good view into the Fed's thinking on where it sees inflation and the economy going from here, as it delivers its policy update tomorrow, which will include a decision on interest rates and a speech from Fed Chairman Jerome Powell.