After two months of stock market happiness, Wall Street is waking up from its slumber.
First, the collapse of First Brands Group and Tricolor Holdings reignited long-dormant fears about hidden credit losses. Then, fraud-related writedowns at Zions Bancorp and Western Alliance — wiping more than $100 billion in value from U.S. bank stocks in one day — fueled concerns that lending stress is more pervasive.
Until recently, investors have shrugged off everything from government shutdowns to strained valuations, buoyed by the AI boom and the resilience of consumer data. This left aggressive positioning. According to Société Générale, allocations to risky assets such as stocks and credit rose to 67% of portfolios tracked at the end of August, a level close to peaks.
Stocks still ended the week with a sharp gain, extending a bull market that has already added $28 trillion in value after President Donald Trump backed away from last Friday’s tariff threats. But six days of asset volatility show that a deeper anxiety is setting in: credit fragility. More than $3 billion was withdrawn from high-yield bond funds in the week through Wednesday, according to EPFR Global. Dynamic risky transactions like crypto, once untouchable, are also losing steam.
In quantitative portfolios, strategies that limit credit risk are coming back into fashion. According to Evercore ISI, a trading bet against higher-leveraged companies – and supporting their lower-leveraged peers – is once again generating big gains, echoing trends seen before the dot-com peak.
None of these movements indicate a lasting bearish turn. But the tone has changed. Taken together – an overhaul of lax credit standards, the collapse of leveraged companies, speculative flows disconnected from fundamentals – the echoes of past turning points are stirring a spirit of discipline among a cohort of big money managers.
John Roe, head of multi-asset funds at Legal & General, which manages $1.5 trillion, said his team had taken steps to reduce risk, citing a growing disconnect between investor positioning and underlying fundamentals.
“In recent weeks, we have viewed it as an underappreciated risk amid high, but not extreme, investor sentiment,” Roe said. “This was a key part of a decision to reduce risk-taking and short sell stocks on Wednesday.”
The firm was already underweight credit, citing tight spreads and limited upside potential. And while the Tricolor and First Brands bankruptcies were widely seen as idiosyncratic, Roe’s team viewed them as potential harbingers of broader tensions, particularly among low-income borrowers.
Others had a similar thought.
“I think we are entering a classic credit down cycle,” said Ulrich Urbahn, head of multi-asset strategy and research at Berenberg. “It’s not catastrophic, but there is a growing risk that this will mark a turning point in the wider environment.”
Over the past two weeks, Urbahn said it added equity hedges, reducing its equity exposure by about 10 percentage points and becoming underweight. He sold call options on the S&P 500 to help fund protective bets, and even reduced his positions in gold and silver – increasingly crowded trades.
“After the performance of the year to date,” he said, “there is plenty of motivation to protect strong gains.”
Despite the credit woes, the S&P 500 Index finished the week up 1.7%, even as the S&P Regional Banks Select Industry Index fell nearly 2% in its fourth straight week of losses. High-yield corporate bond spreads, while still historically tight, widened 0.25 percentage points this month to 2.92 percentage points. The VVIX – or vol vol, which tracks the speed of changes in investor sentiment – rose to its highest level since April. A measure of demand for extreme risk insurance also rose to its highest level in six months.
The push into risky assets has not been driven solely by confidence. For active managers, 2025 is shaping up to be one of the worst years on record, with the proportion of long-term actively managed funds outperforming benchmarks falling to 22% in 2025, according to data from Jefferies Financial Group Inc. That pressure has intensified the search for what works, even as fundamentals deteriorate.
At the extreme end of the risk spectrum, crypto has failed to rebound from last Friday’s $150 billion wipeout. Unlike previous crashes, there was no rush by retailers to buy the dip – just silence. This restraint, despite the fall in rates and the relaxation of liquidity, suggests a change: less mania, more risk control. And the chill could extend beyond tokens.
Not everyone sees the recent tremors as a turning point.
Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions, said the selling related to Zions and Western Alliance looked more like an overreaction to isolated stresses than a sign of deeper credit stresses.
“That probably says more about positioning and sentiment than anything else,” he said. Even though spreads are tight, Melson still believes strong fundamentals and strong credit carry. His team recently moved from a slight underweight in stocks to a neutral position. “So neutrality seems like the right way to position yourself,” he said, “until you have a better opportunity to lean more aggressively on being overweight.”
