Don’t forget about diversification (zig and zag in 2025!)
The Sandbox Daily (2.6.2025)
Welcome, Sandbox friends.
Today’s Daily discusses:
diversification benefits in 2025
Let’s dig in.
Blake
Markets in review
EQUITIES: Nasdaq 100 +0.54% | S&P 500 +0.36% | Dow -0.28% | Russell 2000 -0.39%
FIXED INCOME: Barclays Agg Bond -0.10% | High Yield -0.15% | 2yr UST 4.214% | 10yr UST 4.441%
COMMODITIES: Brent Crude -0.52% to $74.22/barrel. Gold -0.46% to $2,879.8/oz.
BITCOIN: -0.91% to $96,420
US DOLLAR INDEX: +0.10% to 107.688
CBOE TOTAL PUT/CALL RATIO: 0.79
VIX: -1.71% to 15.50
Quote of the day
“Every person you meet is fighting a battle you know nothing about. Be kind. Always.”
- Brad Meltzer, Novelist
Don’t forget diversification
The primary benefit of owning both stocks and bonds in a portfolio is diversification, which helps reduce overall risk by balancing the awesome upside growth potential from stocks with the stability, income stream, and downside protection of bonds.
There is a time-tested investment analogy that applies here: don’t put all your eggs in one basket. In this analogy, the eggs are individual investments and the basket is your overall investment portfolio.
As my old and wonderful UBS colleague Justin Waring used to tell me: “we look for some assets that “zig” when others “zag.”
The key to efficient diversification involves the statistical concept of correlation.
Correlation measures the degree to which two assets move together. The maximum correlation is 1.0 (or one can think 100%); in this case, the two assets always move up and down together and no diversification is achieved. The minimum correlation is −1.0 (or −100%); in this case, the two assets always move in the opposite direction and perfect diversification is achieved.
When stock-bond correlations are falling, bonds tend to hold their value or even rise when stocks fall, helping to cushion losses in a multi-asset portfolio. This diversification reduces overall risk and makes returns (and the investor experience) more stable over time.
Meaning, when stock-bond correlation goes from positive/higher to negative/lower, overall portfolio volatility goes down.
At the turn of the century, for 20 years, stocks and bonds were inversely correlated. When stocks fell, quality bonds provided an offset, as yields moved down and bond prices moved higher.
That relationship switched in 2021, when stock and bond returns have been largely moving in the same direction. Dual rallies, dual selloffs. No bueno.
Now, it appears the stock-bond relationship is reverting back to stocks zigging while bonds are zagging.
Recently, the 6-month rolling correlation between stocks-bonds flipped zones such that stock prices and bond prices are moving in opposite directions (bottom pane below, when blue area chart shading is above the 0.0 horizontal line).
How equities digest rising bond yields usually depends on the speed and source of increases as well as the yield level.
With less Fed easing priced into markets, as well as higher bond term premia, bonds should continue to buffer equity drawdowns.
Under the market base case scenario of limited upward pressure on inflation, stock-bond correlations will continue to normalize and benefit multi-asset approaches to an investor’s portfolio.
So, how should an investor with stocks and bonds be positioned?
Higher bond yields alongside current elevated equity valuations and now favorable stock-bond correlations argue for increased bond allocations in multi-asset portfolios.
Bonds now stand a better chance of outperforming cash, while less positive stock-bond price correlations should render bonds a more effective hedge against growth shocks and/or equity drawdowns.
Source: Ned Davis Research
That’s all for today.
Blake
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Welcome to The Sandbox Daily, a daily curation of relevant research at the intersection of markets, economics, and lifestyle. We are committed to delivering high-quality and timely content to help investors make sense of capital markets.
Blake Millard is the Director of Investments at Sandbox Financial Partners, a Registered Investment Advisor. All opinions expressed here are solely his opinion and do not express or reflect the opinion of Sandbox Financial Partners. This Substack channel is for informational purposes only and should not be construed as investment advice. The information and opinions provided within should not be taken as specific advice on the merits of any investment decision by the reader. Investors should conduct their own due diligence regarding the prospects of any security discussed herein based on such investors’ own review of publicly available information. Clients of Sandbox Financial Partners may maintain positions in the markets, indexes, corporations, and/or securities discussed within The Sandbox Daily. Any projections, market outlooks, or estimates stated here are forward looking statements and are inherently unreliable; they are based upon certain assumptions and should not be construed to be indicative of the actual events that will occur.
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