OK, here we go, time to lose some sleep over this! Risk for the S&P 500? Say it ain’t so!
Bank of America has warned that the S&P 500 faces a significant risk of “forced selling” due to growing problems in the opaque private lending market. The bank cautions that a popular investor strategy has created a hidden vulnerability that could see trouble in private credit spill over into public stock markets.
The core of the issue, according to BofA, is that many large asset owners—such as pension funds and endowments—have adopted a “barbell” strategy. This approach involves investing heavily in two extremes: highly liquid, low-cost passive investments like S&P 500 index funds on one side, and complex, high-return illiquid private equity and private credit funds on the other.
This strategy has been popular while markets were stable, but BofA’s warning focuses on what happens when “problems in private lending” emerge. The multi-trillion dollar private credit market has faced growing scrutiny amid higher interest rates, with regulators and bank CEOs recently warning of rising defaults and “cockroaches” in the sector.
The risk to the stock market stems from a severe liquidity mismatch. If investors face losses or need to raise cash from their troubled private credit holdings, they cannot sell them quickly. These assets are “private” and locked up, with no daily public market.
Instead, BofA notes, these investors will be forced to “sell what’s liquid” to meet their cash needs. For most, the largest and easiest asset to sell is their holding in passive index funds. This could trigger a wave of forced selling in the S&P 500, pushing the index down not because of the fundamentals of its listed companies, but because of a contagion event originating in the separate, illiquid private lending world.
—
The immediate market impact of this Bank of America warning is an increase in investor anxiety, as it highlights a significant, non-obvious risk to the S&P 500.
This note could trigger preemptive selling or hedging from funds concerned about this liquidity mismatch and may lead to intense scrutiny of large asset owners who employ this “barbell” strategy. Furthermore, any news of defaults or stress within major private credit funds will now be viewed as a direct and immediate threat to S&P 500 stability, potentially amplifying market volatility as traders anticipate a wave of forced liquidations in public equities.
I know a lot of you are going to shrug this off, with a m’eh. You’re probably right!
This article was written by Eamonn Sheridan at investinglive.com.