This week saw a resurgence of trade conflicts, emerging credit risks in US regional banks, and concerns over the overvaluation of AI stocks, triggering the most intense market turbulence in the US stock market since April. The VIX index surged to 28.99, marking its highest intraday level since late April. Previously booming risk trades like cryptocurrencies lost momentum, plummeting over 8% this week.

“The most turbulent week since April” has ended, shattering the protracted calm in the markets. Despite this, the S&P 500 index recorded an intraday gain exceeding 2% for the first time since April.

Even though on Friday the three major US stock indices opened lower but rose throughout the day, they still accumulated over 1% rebound for the week. However, investors flocked to safe-haven assets like government bonds and gold, which led to significant outflows from high-yield bond funds, while once popular risk trades like cryptocurrencies lost steam.

Various indicators suggest a shift in market sentiment. Not everyone believes this marks the beginning of a bear market, yet subtle changes in investor sentiment, a renewed examination of credit risks, and a cooling of speculative trading are prompting major fund managers to adopt a more cautious and defensive stance. After several months of one-sided upside movement, the market is beginning to learn how to coexist with volatility.

The alarm bell after the trillion-dollar risk accumulation The stock market ended the week on a solid note, continuing a bull market that has added $28 trillion in value after Trump stepped back from tariff threats.

However, the continued six-day volatility across asset classes indicates a deeper-seated anxiety is pervasive: credit vulnerabilities.

Reports indicated that the collapse of automotive suppliers First Brands Group and auto loan company Tricolor Holdings reignited long-dormant concerns about credit losses. First Brands' advisors admitted in court last Thursday that they could not trace $1.9 billion in assets meant to serve as collateral for creditors, revealing that the company’s bank account held only $12 million.

This week, concerns grew as Zions Bancorp and Western Alliance revealed fraud-related impairment losses, erasing over $100 billion in market value from US bank stocks in one day and raising fears of broader loan pressures.

These events directly impacted their respective sectors. The S&P Regional Banks Select Industry Index has now declined for four consecutive weeks. This came after a period when investors, buoyed by the AI craze and resilient consumer data, dismissed all manner of risks from government shutdowns to overvaluations, leading to seemingly aggressive positioning.

According to Société Générale data, by the end of August, the allocation of tracked portfolios to risk assets such as equities and credit had risen to 67%, nearing peak levels.

Safe-haven sentiment prevails; VIX index spikes One of the most notable features of this week has been the sharp return of market volatility. The VIX index, which gauges market fear, briefly hit 28.99, its highest intraday level since late April. The VVIX index, which tracks changes in investor sentiment, also reached a high not seen since April, indicating that the underlying stability of the market is weakening behind seemingly robust stock indices.

At the same time, data from the CME Group revealed that investors are buying options betting on the VIX index possibly soaring to 47.5 and 50, with a measure of tail risk hedging demand also reaching a six-month high.

Jordan Rizzuto, Chief Investment Officer at GammaRoad Capital, stated, “The list of things to worry about is actually increasing. In this context, we should expect higher volatility.”

High-risk assets retreat, digital currencies hit hardest As safe-haven sentiment grew, previously sought-after high-risk assets began to retreat. The digital currency market became a disaster area, with Bitcoin dipping to a low not seen since July, culminating in an approximate 8.7% drop for the week, marking its worst weekly performance since February.

Notably, unlike previous instances of steep declines where retail investors rushed in to buy the dip, the market's muted response this time indicates “fervor is diminishing, and risk awareness is rising.” This cooling trend might not be limited to the cryptocurrency sector.

According to EPFR Global data, over $3 billion flowed out of high-yield bond funds in the week up to this Wednesday. Although the spread on high-yield corporate bonds remains at a historical low, it has expanded by 0.25 percentage points to 2.92 percentage points this month.

In quantitative portfolios, strategies to avoid credit risks have also gained favor again. According to Evercore ISI, a hedge trade that shorts highly leveraged companies while going long on low-debt peers has once again delivered strong returns, echoing patterns seen just before the internet bubble peak.

Fund managers adjust strategies to shift towards credit risk defense John Roe, head of multi-asset funds managing $1.5 trillion at Legal & General, stated that his team has decided to reduce risk exposure and has shifted to shorting stocks, citing increasing disconnection between investor positioning and fundamentals. He added that the firm has previously underweighted credit assets and viewed the collapses of Tricolor and First Brands as potential warning signs of broader stress, especially among low-income borrowers.

Ulrich Urbahn, Head of Multi-Asset Strategy and Research at Berenberg, expressed a similar view. He stated, “I believe we are entering a typical credit downturn cycle, which is not catastrophic, but it signals that the risk of a turning point in the broader environment is increasing.”

Over the past two weeks, he has increased stock hedging, decreasing stock exposure by about 10 percentage points and selling call options on the S&P 500 index to protect strong year-to-date gains.

Not everyone believes the market has reached a turning point Despite rising concerns, not everyone believes that the market has reached a decisive turning point. Some analysts argue that the recent turbulence is more of an overreaction to isolated events rather than a signal of systemic issues.

Garrett Melson, a portfolio strategist at Natixis, pointed out that the sell-off related to Zions and Western Alliance may reflect market positioning and sentiment more than underlying credit pressures. He asserted, “The fundamentals of the credit market remain robust, and our team has recently adjusted stock positioning from slightly underweight back to neutral.”

Matt Wittmer, a portfolio manager at Allspring Global Investments, agrees that after a rapid and substantial rise in the market, recent volatility is "healthy" and indicates that the market is not "overly ahead."

His firm continues to overweight financial stocks such as JPMorgan Chase and Citigroup, maintaining their positions through the recent extreme fluctuations.

Risk disclaimer: Markets are risky; investment requires caution. This article does not constitute personalized investment advice and does not consider individual users' specific investment objectives, financial situations, or needs. Users should assess whether any opinions, views, or conclusions in this article align with their particular situation. Investment decisions are made at one's own risk.