2025’s Winners and Losers, from Gold to Small Cap Stocks to the 60/40 Portfolio

Key Concepts

• Market Volatility
• Asset Classes (Winning and Losing)
• Diversification
• 60/40 Portfolio
• Three-Fund Portfolio
• Diversified Portfolio
• Geopolitical Risk
• US Trade War
• Inflation
• High Interest Rates
• Budget Battle/Government Shutdown
• VIX Index
• Gold
• Central Banks (China)
• US Dollar (Reserve Asset Status)
• Debt-to-GDP Ratio
• Gold ETFs (GLD)
• Cryptocurrency (Bitcoin, Ethereum)
• Speculative Asset
• Fear of Missing Out (FOMO)
• International Stocks
• US Market Valuation
• Real Estate Sector
• Commercial Real Estate
• US Small Cap Stocks
• AI Trend
• High Yield Bonds (Junk Bonds)
• US Treasuries
• Safe Haven Asset
• Private Credit
• Financial Services Sector
• Bankruptcies
• Lending Standards
• Quality and Value Investing
• Economic Data (Inflation)
• Earnings Season

Market Volatility and Asset Class Performance in 2025

The current market environment in late 2025 is characterized by increased volatility, fueled by factors such as potential US tariffs on China, ongoing budget battles in Washington D.C. leading to concerns about government shutdowns, and broader worries about economic growth and inflation. While this macro environment is pressuring investment portfolios, it also underscores the importance of diversification.

Understanding Market Volatility

• VIX Index: The VIX index, a measure of market expectations for future volatility, has been in the low 20s recently. Historically, the average VIX since 1990 is around 19-20. Readings in the low 20s are not considered extreme and serve as a healthy reminder that volatility is an inherent part of long-term investing. Earlier in the year, calmer markets might have led to complacency.

Winning Asset Classes

• Gold: Gold has reached record highs in 2025, primarily driven by significant purchases from central banks, notably China. This trend is attributed to a shifting perception of the US dollar as a stable reserve asset due to high US government debt (debt-to-GDP ratio around 120%). Retail investor flows into gold ETFs like GLD have also contributed, driven by concerns about macro instability and potential inflation.
• Cryptocurrency (Bitcoin): Bitcoin and other cryptocurrencies have experienced a strong run, despite recent sell-offs linked to US trade policy. Its performance is driven by its nature as a speculative asset, where fear of missing out (FOMO) can create momentum. Weakness in the US dollar and questions about its future also play a role.
• International Stocks: International stocks have continued to outperform the US market over the past couple of months, with the weakness in the US dollar acting as a tailwind.
  • Valuation: The US market is currently trading at a 2-3% premium to its estimated fair value, offering a limited margin of error for corporate earnings growth.
  • Opportunities Abroad: Valuations outside the US remain relatively low. Investors who haven't rebalanced their portfolios might still be underweight in international equities despite their recent strong performance.

Losing Asset Classes

• Real Estate Sector: While up approximately 6% year-to-date, the real estate sector has been one of the weakest performers in the US market. Areas like hotels, residential properties, and storage have lagged. Structural issues persist in commercial real estate. However, the recent underperformance, even over the past couple of years, has led to attractive valuations, with the sector trading at an estimated 8% discount to fair value, making it one of the most undervalued sectors.
• US Small Cap Stocks: Small cap stocks have underperformed due to a strong focus on AI trends, which has benefited large-cap tech companies like Nvidia, Broadcom, and Microsoft. Smaller companies are also more sensitive to economic weakness and tend to carry more debt, making them vulnerable during recessions or economic slowdowns.
• Certain Bond Segments (High Yield): There has been some weakness in high yield, or "junk," bonds in the past month or two. This is likely linked to concerns about economic growth, as these bonds tend to suffer during recessions or economic slowdowns.

Impact on US Treasuries and the US Dollar

• US Government Shutdown and Treasuries: As of October 22nd, the US government shutdown has had a limited impact on the 10-year Treasury yield, which was just below 4%. However, a prolonged shutdown could increase concerns. The larger potential concern for Treasuries remains the sustainability of US debt levels, which could put upward pressure on yields if markets become more worried.
• US Dollar Weakness: The US dollar is not having a strong year and could weaken further. The dollar tends to move in long-term cycles of 6-10 years. After a period of significant strength from 2011 to 2024, the current weakness might persist. Factors contributing to this include rising government debt levels and potential interest rate cuts by the Federal Reserve.

Portfolio Performance in 2025

• 60/40 Portfolio (60% Stocks, 40% Bonds): This classic portfolio has performed well, up approximately 12% year-to-date, with both US stocks and investment-grade bonds contributing positively.
• Three-Fund Portfolio (e.g., 40% US Stocks, 20% International Stocks, 40% Investment Grade Bonds): This simpler diversified approach has also performed well, up about 14% year-to-date, with the international exposure being a significant positive contributor.
• More Diversified Portfolio (including Gold, Real Estate, Emerging Markets): This portfolio has performed even better, up approximately 16% year-to-date, driven by the strength in gold and other asset classes.

Key Takeaways for Investors

Amy Arnot's advice for investors as 2025 concludes and market volatility persists:

• Embrace Volatility: Market volatility is a normal part of long-term investing.
• Focus on Long-Term Goals: Avoid getting overly distracted by daily market headlines.
• Diversify: Ensure your portfolio is well-diversified across different asset classes.
• Rebalance: Regularly rebalance your portfolio to maintain your desired asset allocation.

Crypto as a Diversifier and Safe Havens

Dan Kemp, Chief Research and Investment Officer at Morningstar Investment Management Europe, offers a different perspective on cryptocurrency and safe-haven assets.

• Crypto is Not a Diversifier: Kemp argues that cryptocurrency does not act as a diversifier for stocks. A diversifier should act as a shock absorber during market downturns, helping investors avoid emotional decisions. Crypto, however, tends to act as an accelerant, performing well during optimistic periods but falling faster than equities during market downturns. This behavior is not helpful for diversification.
• Government Bonds as Safe Havens: Kemp identifies government bonds as the tried-and-true safe-haven asset. They tend to perform better when sentiment is negative and there are concerns about global economic events. While not foolproof, they are generally the best diversifier across most market conditions.

Financial Services Sector and "Cockroach Hunt"

• The "Cockroach" Analogy: Referencing Jamie Dimon's quote, "where you find one cockroach, there's normally more," Kemp explains this refers to bankruptcies, particularly within the financial services sector. Recent bankruptcies have been linked to the use of novel financing forms, often categorized under "private credit."
• Concerns in Private Credit: The recent bankruptcies have raised concerns about potentially lax lending standards in the private credit market. Investors are now looking for further "cockroaches" – companies facing credit problems or bankruptcies due to these lending practices.
• Investor Opportunities:
  • Quality and Value: Investors should focus on quality and value. While many high-quality growth stocks are currently highly priced, the emergence of more "cockroaches" could lead to a loss of confidence and a decline in prices, creating opportunities.
  • European Banks: Despite the bankruptcies being primarily linked to US markets, European banks bore the brunt of the market declines. There are still bargains to be found in this market.
  • Investing During Fear: The key for investors is to be ready to invest when others are fearful, which is often the most challenging aspect.

Upcoming Economic Data and Earnings Season

• Economic Data: The upcoming week will feature important economic data, including inflation figures due on Friday. Due to the government shutdown, there has been a lack of recent economic data. The inflation data is crucial as it impacts cost-of-living increases for social security.
• Earnings Season: The US is in the middle of earnings season, with companies reporting their quarterly results. Surprises in these reports are expected and could lead to significant market movements, prompting investors to buy or sell holdings.

Conclusion and Investor Reminders

The episode emphasizes that market volatility is a constant and that investors should focus on long-term strategies. Key takeaways include the importance of diversification, staying focused on goals, and rebalancing portfolios. While gold and international stocks have performed well, and real estate and small caps have lagged, the overall market environment presents both challenges and opportunities. Investors are advised to be patient, look for quality and value, and be prepared to invest during periods of market fear.