"AI Disrupts Everything" and the Private Credit Storm Sweeps Through, Financial Sector Faces its Most Brutal Quarter in 6 Years.

The S&P 500 financial sector index has fallen by 11% since the beginning of this year, and by the end of March, it is expected to see its worst first quarter performance since 2020. With the pessimistic market sentiment of "AI disrupting everything" sweeping through global stock markets, combined with growing concerns among investors about the private credit industry's cracks spiraling out of control, the financial sector, which has attracted investors for a long time with many labels related to "stability" such as "value, low volatility, and safe haven," has been weakening significantly amidst intense volatility this year, prompting investors to withdraw from the "long-term value investment" theme. Amid escalating investor panic and anxiety, a series of well-known financial giants such as BlackRock, Inc. (BLK.US), Morgan Stanley (MS.US), and Blackstone (BX.US) have become the latest large Financial Institutions, Inc. to impose redemption restrictions on private credit-type debt funds. In addition to the extreme panic among investors caused by the private credit industry falling into frequent default turmoil, a large part of the concerns are closely related to the pessimistic sentiment driven by the "disrupt everything" narrative of artificial intelligence. Leading financial industry giants on Wall Street have a heavy exposure to single-function SaaS software companies in their direct lending investment portfolios. What most investors did not anticipate is that, under the two major negative catalysts in the current market, the narrative of "AI disrupting everything" and the cracks in private credit, which are only second to the Middle East wars, the most severely affected are not only the software sector and the credit assets mired in default turmoil, but also the financial sector serving as a "credit intermediary and asset pricing stabilizer." Statistics from Goldman Sachs Group, Inc. show that global hedge funds dumped the S&P 500 financial sector index in mid-March, becoming the sector with the most net sales this year. In other words, the market is not only concerned about the prospects of software companies being squeezed by near-omnipotent AI intelligences, but also worried that the credit default turmoil will affect a wider range of financial stocks, and that the "disrupt everything" narrative of AI will ultimately impact financial institutions that directly or indirectly hold these risk assets. AI disrupts everything! Where the "disruption theory" goes, no grass grows Although Wall Street giants like Morgan Stanley do not expect a widespread systemic impact on the global financial markets similar to the 2007-2008 subprime crisis, strategists warn that as large loans issued in the low-interest rate environment of the pandemic period come due, the AI-driven disruption could significantly increase the default rates of various industries, including losers in sectors like software. "Overall, we expect direct loan default rates to reach 8%, approaching peak levels from the pandemic period," wrote a team led by Joyce Jiang, a senior strategist at Morgan Stanley. They cited PitchBook statistics indicating that the software industry's direct loan wall of maturities is "very high," with about 11% of software direct loans due by the end of next year, followed by another 20% due in 2028. Direct loans are the most core and common subsector of private credit. The team added, "We expect defaults to concentrate in the software industry and other industries most likely to be replaced by general AI models, which is different from the pandemic period; in the pandemic period, defaults peaked simultaneously across multiple industries." According to Morgan Stanley, approximately 19% of direct loans in the portfolio are closely related to software companies. However, the strategists from Morgan Stanley say that in the $1.8 trillion private credit market, these localized default risks are "significant but non-systemic" for the broader private credit market, as overall balance sheets of companies look healthy compared to average levels, particularly after the Fed's aggressive rate hikes in 2022. With leading companies like Anthropic and OpenAI recently releasing a series of AI agent products focusing on efficient workflows, which could potentially replace certain functional software services at a much lower cost, the global software sector has endured heavy sell-offs. The iShares Expanded Tech-Software Industry ETF (IGV), which tracks the American Software, Inc. Class A industry, has fallen by about 30% from its all-time high in September and is now firmly in bear market territory. The pessimistic tone of "AI disrupts everything" since February is mainly due to the escalating concern in the market that AI-powered agent workflows like Claude Cowork and OpenClaw (formerly known as Clawdbot, Moltbot) could weaken the entire software empire based on SaaS subscription revenue model. This selloff has quickly spread to insurance, real estate, truck transportation, and any other industry that appears to be reliant on per-seat revenue model or labor-intensive business model - the market believes these industries are likely to be completely disrupted by AI. Not only in the US stock market, but the software sector of global stock markets has been consistently hit hard by the pessimism of "AI disrupts everything" since February. Despite the surge in buybacks in the US software sector, investors are still not convinced, as the market is genuinely concerned whether the fundamental business models and long-term fundamentals will be completely reshaped by AI intelligences like Claude Cowork and OpenClaw. Orlando Bravo, co-founder of Thoma Bravo, a leading American private equity firm specializing in software and technology, recently stated that AI will disrupt software companies faster, and that the substantial impact on valuations some companies face is "very reasonable." He said at a Thoma Bravo investor conference in Miami, "There are many software companies in the public market that will be thoroughly disrupted by cutting-edge AI technology. These software companies will be disrupted by AI one way or another." The "Anthropic storm" that has devastated software stocks is still brewing in global stock markets, and this sell-off is accelerating into traditional industries like wealth consultancy, real estate consultancy, and any other industries that seem poised for complete disruption by AI. The market's pessimistic expectations of "AI disrupts everything" have hit various industry sectors like dominoes, from software, SaaS, PE to insurance, traditional investment banking, wealth management, real estate and property management, and even logistics sectors have witnessed a succession of sharp declines. AI has swept through these traditional industries one by one in the past three to four weeks, with investors accelerating the sale of potential "losers." The "yellow warning light" moment has arrived, but the most dangerous moment is yet to come In a recent report, J.P. Morgan's macro analysts echoed the views of the Morgan Stanley strategists, stating that "market concerns about AI entities and private credit triggering a default crisis have been exaggerated," as direct loans currently account for only about 9% of total corporate borrowing. They also emphasized that although there are some retail investors exposed, the investor base remains primarily institutional investors on Wall Street, the institutional investors with robust liquidity buffers are less sensitive to redemption panic, reducing the likelihood of rapid outflows or forced mass sell-offs of underlying credit assets. Aaron Mulvihill, a global alternative investment strategy at J.P. Morgan Asset Management, warned that investors should be selective in this area. "I would say this is a yellow warning light for the financial sector, not a red warning light symbolizing a financial crisis moment. At this stage, it's not a signal to completely avoid private credit, but certainly a cautious signal to choose wisely," Mulvihill said. He added, "Investors can decide for themselves whether to steadfastly and long-term allocate to a particular industry, but it is important to understand where these investments are directed - whether these companies will benefit from the AI wave or have no survival space in the face of AI, and make wise choices." The rapidly growing private debt sector has come under intense scrutiny and pressure in the market in recent weeks. Previously, alternative asset management giant Blue Owl, one of the leaders in private credit, announced the rare sale of assets last month and canceled investors' redemption rights from its OBDC II fund, opting instead for distributions linked to future earnings and asset sales. Blue Owl's stock has fallen by nearly 40% this year, while its peer and longtime strongest competitor Ares Management has fallen by 34% during the same period. As a leading alternative finance giant that lends to private enterprises, Blue Owl's stock price is on the brink of a relative peak compared to the ongoing political conflicts of GEO Group Inc. Other financial companies have also implemented restrictions in recent days, including the unlisted Cliffwater LLC and the world's largest asset management giant BlackRock, Inc.; BlackRock, Inc. earlier this month limited the redemption proportion for its flagship credit fund to 5%. BlackRock, Inc.'s stock has fallen by about 10% this year. Earlier this month, faced with an increasingly high volume of redemption requests, the alternative asset management giant Blackstone took an unusual step by requiring some senior executives to collectively contribute $150 million to help meet funding needs, instead of imposing withdrawal limits on investors as some private credit peers have done. Earlier this month, BCRED, in response to a surge in redemption requests, used more than 25 senior executives to collectively invest approximately $150 million of their own funds, along with Blackstone's own capital, to meet liquidity needs. An analyst team at Goldman Sachs Group, Inc. expects that a redemption wave will continue in the short term. Alexander Blostein and his team wrote earlier this month in a report, "Coupled with redemption rates in the single digits, the private credit industry is likely to see net outflows in the first quarter, and this condition is likely to continue for the next few quarters, but limiting redemptions to 5% may alleviate immediate net redemption pressure." They added, "We expect that the cumulative net outflow rate of retail private credit products over the next two years will reach 20%-30%." Amid escalating concerns about transparency, valuation, and liquidity in the $1.8 trillion private credit industry, a major signal has undoubtedly emerged from Blackstone Inc.'s flagship private credit fund, which is planning to sell a batch of bonds assets supported by a wider portion of its $825 billion portfolio. This step is a mitigating and crucial signal regarding whether the private credit market will collapse. In this cycle of sell-offs driven by "AI reshaping + private credit concerns," the traditionally stable financial sector is one of the first core sectors to be heavily sold off, not due to sudden collapses in their own fundamentals, but because they are at the intersection of fundamental disruption analysis, credit risks, liquidity risks, and opaque valuation risks. For the market, this is more like a "yellow warning light" rather than a "red alert" - the largest financial giants on Wall Street are still able to finance and manage liabilities actively through various channels, and can navigate liquidity through tools like CLO; the "losers" will undoubtedly face greater challenges in software allocations, redemption pressures, and even fundamental reassessments. Consequently, the current decline in the financial sector fundamentally represents the capital market pre-pricing the "credit stratification in the era of AI."