Cracks behind the S&P 500 Index hitting a new high: the financial sector is down 6% this year, and a $2 trillion undercurrent in private credit—worth 2 trillion dollars—is spreading.

The S&P 500 keeps hitting new highs, but financial stocks are becoming the weakest sector—behind it is the rapid acceleration of credit deterioration in a $2 trillion private credit market, which is now being exposed more clearly.
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Table of Contents

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• Bank profits hit new highs, yet the sector hits new lows
• $2 trillion private credit: from “cockroaches” to systemic warning
• Blackstone’s flagship fund faces $3.7 billion in redemptions, a clear signal of retail retreat
• Technical signals: 90% of historical scenarios point to a correction
• The “Trump dividend” expectations at the start of the year have been completely dashed

Deep dive: With the S&P 500 setting record highs one after another and Q1 earnings growth reaching 27.1%, the financial sector has still fallen more than 6% year-to-date to become the worst performer among the 11 sectors. The XLF relative performance versus the broader market has already dropped to the lowest level in history since 1998—worse than during the financial crisis and the COVID-19 period. The driving force behind it is the accelerating exposure of cracks in the $2 trillion private credit market: Blackstone’s flagship fund has faced a $3.7 billion redemption wave, and just two days ago, the FSB issued a systemic risk warning.

The S&P 500 closed April at a record high of 7,209 points. Q1 earnings growth was 27.1%, the highest since Q4 2021, and 84% of constituent stocks came in above expectations. On the surface, the U.S. stock market has never been healthier.

But the financial sector is sending a completely different signal. The XLF ETF tracking the sector has fallen more than 6% year-to-date, making it the worst performer among all 11 S&P 500 industries. The severity of this divergence has already surpassed the levels seen during the 2008 financial crisis and the 2020 COVID-19 shock. According to FactSet and MarketWatch data, XLF’s performance relative to the S&P 500 has fallen to its lowest level in history since the index was established in 1998.

Scott Brown, founder of Brown Technical Insights, said bluntly: The U.S. stock market can’t do without support from the financial sector, and financial stocks are currently not even participating in the rally.

Bank profits hit new highs, yet the sector hits new lows

This round of weakness in the financial sector is especially counterintuitive.

According to FactSet data as of May 1, Q1 earnings growth for the S&P 500 reached 27.1%, the highest since Q4 2021. Financial sector revenue growth also ranked among the top four. The major banks—including JPMorgan, Bank of America, and Wells Fargo—reported strong quarterly results in April.

But what the market trades is not the quarterly income statement, but risk exposures that are invisible on the balance sheet.

The root cause points to private credit. This market, roughly $1.5 trillion to $2 trillion in size, expanded rapidly in the gap created after the 2008 financial crisis when banks contracted lending. Now it is deeply intertwined with banks, insurance companies, and asset management institutions. Once credit deterioration occurs, the transmission chain is far longer than what the surface suggests.

$2 trillion private credit: from “cockroaches” to systemic warning

JPMorgan CEO Jamie Dimon previously compared problems emerging in private credit to “cockroaches”—if you see one, there may be more behind it. This metaphor is now supported by an increasing amount of data.

On May 6, the Financial Stability Board (FSB) released a stern risk report on private credit. It warned that the market’s complexity, high leverage, and deep interconnectedness with the banking system could amplify stress in adverse scenarios, posing risks to broader financial stability. The FSB specifically noted that high leverage in private credit is concentrated in technology, healthcare, and services, and that it has never been tested through a prolonged economic downturn.

The report also flagged an ominous sign: more private credit borrowers are starting to rely on payment-in-kind loans (payment-in-kind loans, i.e., using new debt to repay old debt instead of using cash), which is generally seen as a sign of worsening credit conditions.

Two days ago, Sarah Breeden, Deputy Governor of the Bank of England, publicly expressed concerns about private credit asset quality, valuation discipline, and liquidity issues. The European Central Bank has also issued similar warnings recently. Barclays disclosed that its private credit exposure was $20 billion, and Deutsche Bank’s was about $30 billion.

Blackstone’s flagship fund faces $3.7 billion in redemptions, a clear signal of retail retreat

Beyond macro-level warnings, the turmoil in capital is even more direct.

According to a Reuters report on March 3, Blackstone’s $82 billion flagship private credit fund BCRED received $3.7 billion in redemption requests in the first quarter. The redemption ratio reached 7.9% of the fund’s assets, the highest record since the fund’s inception. JPMorgan analysts characterized this as the first-ever net outflow in BCRED’s history, calling it a “major expression of sharply deteriorating investor sentiment toward direct lending.” Blackstone was forced to raise the usual 5% redemption cap to 7% and injected $400 million from the company and executives to meet all redemption requests.

The day after the news was released, Blackstone’s stock fell as much as 8% to a two-year low.

Another private credit giant, Blue Owl Capital, is in an even more precarious position. Its flagship fund OCIC saw redemption requests of 21.9% in the first quarter, but the company only paid out proportionally under the 5% cap—meaning about three-quarters of redemption requests were rejected. Its technology-focused fund OTIC had even higher redemption requests of 17% in the previous quarter.

The assessment from investment bank RA Stanger is quite striking. It believes alternative assets are entering a “sharp turn” phase, with capital moving out of private credit. It also expects that by 2026, BDC (business development company) capital formation will decline by about 40% year over year.

Based on a PitchBook survey of about 100 credit firms, 35% of respondents believe negative perceptions of private credit are the industry’s biggest headwind, and market sentiment has deteriorated significantly compared with six months ago. Morgan Stanley expects private credit default rates to rise to 8%, with about 20% of loans going to software companies—making the outlook for these assets particularly worrying under the impact of AI.

Technical signals: 90% of historical scenarios point to a correction

Turning back to the technical side of the financial sector itself, the signals are also not encouraging.

Scott Brown pointed out that XLF is not only continuing to fall during periods when the S&P 500 hits new highs, but it has also been consistently trading below the 200-day moving average. Historical data show that in the prior 32 times when the S&P 500 hit new highs while XLF was below its 200-day moving average, one month later the S&P 500 declined 29 times, with an average drop of 3.3%. The win rate six months later is closer to a 50/50 split, but the maximum drawdown in the downside range is as high as 41.5%, indicating that tail risk is unusually large and skewed to the downside.

Among all 11 SPDR sector ETFs tracking the S&P 500, XLF is currently the only sector whose price is below both the 50-day moving average and the 200-day moving average—meaning both short-term and long-term trends are weak.

Historically, the financial sector has issued early warnings ahead of market peaks twice. In April 1999, the relative weakness of XLF versus the S&P 500 began to emerge about 11 months before the S&P 500’s final peak. In February 2007, XLF again issued warning signals about 8 months ahead of the market top.

The “Trump dividend” expectations at the start of the year have been completely dashed

The financial sector was heavily expected at the start of the year. The market generally believed that Trump’s second term would bring lower interest rates and looser regulation, creating a favorable environment for banks, insurance companies, and asset management institutions.

According to Investing.com reports in early April, the result was exactly the opposite. More than a year into Trump’s second term, the financial sector has become the worst-performing sector in the S&P 500. Rate cut expectations failed to materialize; private credit “landmines” surfaced; conflicts in the Middle East pushed up oil prices and inflation expectations—multiple headwinds combined.

Melissa Brown, head of global investment decision research at SimCorp, pointed out that the financial system is highly interconnected, and that related risks in the private credit space may spread more widely than currently expected.

Scott Brown’s advice is cautious rather than aggressive. It’s not easy to judge market tops in the current environment, but investors may consider gradually reducing holdings rather than continuing to chase rallies—and it’s even more inappropriate to add new capital to the market.