For better or worse, there’s no such thing as a crystal ball that predicts markets. Instead, the best we have are indicators and areas of the market that are more likely to precede movement of the economy. Among the eleven major sectors of domestic equities, the financial sector is the most likely to foreshadow movement in the broader economy. While the last three years were extremely strong for both the economy and the financial sector, the start of this year has been a very different story.

The State Street Financial Select Sector SPDR ETF (XLF) is down more than 10.8% YTD—its worst beginning to a year besides of the start of Covid since 2009. The fund is back to price levels first achieved in 2024, and its fund score has fallen to a mediocre 3.08, which is its lowest since late 2023. Meanwhile, the group is down to the middle of DALI after sitting in the number one spot as recently as last March. The broader sector has unquestionably weakened, but which areas have taken the largest hit, and are there concerning catalysts causing the decline?

Banks have seen the most downside within financials over the last several months, and regional banks have been hit especially hard. Regional banks focus heavily on lending to small businesses, real estate developers, and local consumers, making their performance directly tied to local credit conditions and economic activity. Deteriorating credit conditions (read more below), commercial real estate woes, and consumer spending concerns have all served as recent headwinds. The State Street SPDR S&P Regional Banking ETF (KRE) is down more than 11% over the last month, moving to a negative trend for the first time since last year. While KRE holds a solid fund score of 4.67, its recent performance marks notable divergence from previous action, making it an area to watch for further weakness in the coming months.

One financial area we previously highlighted as experiencing weakness was payment processors, whose movement often coincides with expectations of consumer spending. While the subgroup has been disrupted by potential legislation limiting fees and interest charges, it has also fallen further due to lowered expectations of consumer spending, even among the higher tax-bracket demographic. Last year saw significant discussion about the “k-shaped” US economy in which businesses and the upper class continue spending while the average American failed to enjoy the same benefits. Notably, American Express (AXP) was an exception to downside several months ago as its high-end customer base was made it resilient in the face of declines from Visa (V) and Mastercard (MA). However, the last couple months have seen it drop by 20% from highs, falling into a negative trend and moving down to hold territory as an oversold 3 for 5’er.

AXP’s selloff is partially due to the potential for AI‑driven white‑collar layoffs to dampen spending by its affluent customer base. When combined with potential business struggles and increases in credit risk, there are some initial signs that the upper branch of the k-shaped economy is starting to slow down. If financials truly are a reflection of the economy and its potential deceleration, then the sector deserves more attention in the coming months as the economy continues to navigate uncertainty. Regardless of what might be driving the sector lower, the relative strength of the sector has undoubtedly been headed in the wrong direction of late, even if it remains in ok territory for the time being. 

In Friday’s trading, the ICE BofA US High Yield Index Option Adjusted Spread (HIGHYIELDSPREAD), which measures the yield spread between high yield bonds and US Treasuries, reversed up into a column of Xs reflecting widening high yield spreads. The other high yield spread index that we track on the site (CBUS10YRSPREAD) reversed into Xs in February. The widening of high yield spreads is potentially a sign of a risk-off shift toward credit in the bond market and a warning sign to high yield investors. There have already been signs of weakness in high yield bonds – in the Asset Class Group Scores, the high yield corporates group has seen its average score decline from around 3.15 and the beginning of the year to its current score of 2.74.

More significantly for many investors, high yield spreads are also considered to be a bellwether for the economy (or at least economic sentiment) and equities. When investors are worried about the possibility of recession and by extension that borrowers (i.e., bond issuers) won’t be able to service their debt, they demand a higher return for the (perceived) increase in risk and high yield spreads widen. Conversely, when the economy is perceived as being strong, investors are more willing to lend and high yield spreads contract. In an extreme example, high yield spreads widened by more than 700 bps in March of 2020 amid fears of an economic collapse at the outset of the COVID-19 pandemic. Last year, CBUS10YRSPREAD rose about 180 bps in March and April amid tariff worries.

The economy and the stock market are not one in the same, but there is a typically a strong relationship between the two and US equities have historically performed significantly better when high yield spreads are narrowing, indicating favorable economic conditions. The table below shows the quarterly performance of the S&P 500 when high yield spreads are narrowing versus when they are widening. It is also apparent that the magnitude of the change is also change is also significant as the S&P has performed better during quarters when spreads narrowed significantly and worse when they widened by a large amount.

The practical implication of this relationship is that equity investors would be well-served to keep an eye on high yield spreads as widening spreads could signal trouble for stocks while narrowing spreads have historically been associated with positive returns. Another consequence of the relationship between high yield spreads and equities is that investors seeking safety and diversification from their fixed income allocations may want to limit their exposure to high yield bonds. High yield bond prices decline as spreads widen and, as we’ve seen, equities also tend to perform poorly during periods when spreads are widening. Therefore, investors with large high yield allocations are likely to see their bond portfolio decline at the same time as their equity exposure.

We don’t want to overblow the significance of the reversal on HIGHYIELDSPREAD’s chart, as you can see there was another reversal in the last year that was ultimately short-lived and it does not necessarily mean that the S&P will finish the quarter in the red. But, with other signs – like US equities falling to third in DALI – that sentiment may be shifting to risk-off it is worth taking note of what the bond market has to tell us.

Daily Option Ideas for March 12, 2026