Monthly portfolio brief

Published February 6, 2025

Volatility rises, markets broaden: The case to diversify strengthens

What you need to know

  • Markets climbed higher in January amid walls of worry and an uptick in volatility, demonstrating the importance of staying invested despite a return to more normal levels of volatility.
  • Markets also displayed strong breadth, generally boosting well-diversified portfolios following a relatively strong 2024.
  • Broadening market leadership strengthens the case for diversification, and a disciplined rebalancing strategy can help ensure a portfolio performs as you intend.
  • Opportunistically, stocks appear more attractive than bonds in this environment. We favor U.S. stocks, even if gains moderate or volatility rises.

Portfolio tip

Large allocations to a small number of investments or sectors can increase the risk that your portfolio may not perform as you expect. You can spread risks by diversifying and rebalancing.

 How have markets performed?
Source: Morningstar, 1/31/2025. U.S. large-cap stocks represented by S&P500 TR Index. International large-cap stocks represented by MSCI EAFE NR Index. U.S. mid-cap stocks represented by Russell Mid-cap TR Index. U.S. small-cap stocks represented by Russell 2000 TR index. International small- and mid-cap stocks represented by MSCI EAFE SMID NR Index. Emerging-market equity represented by MSCI Emerging Markets NR Index. U.S. investment-grade bonds represented by Bloomberg US Aggregate TR Index. U.S. high-yield bonds represented by Bloomberg US HY 2% Issuer Cap TR Index. International bonds represented by Bloomberg Global Agg Ex USD TR Hgd Index. Emerging-market debt represented by Bloomberg Emerging Market Agg Index. Cash represented by Bloomberg US Trsy Bellwethers 3Mon TR Index. Past performance does not guarantee future results. Market indexes are unmanaged, cannot be invested into directly, and are not meant to depict an actual investment.

Where have we been?

Markets were broadly higher in January, supported by a solid economic backdrop, generally boosting well-diversified portfolios following a relatively strong 2024. Over the past 12 months, markets have been propelled by falling inflation, expectations for monetary policies to ease, and surprisingly resilient economic growth. This has resulted in solid returns across our 11 recommended asset classes.

These trends have generally remained intact so far this year, helping power markets higher even if the path of disinflation becomes slower or more bumpy, central banks display a more cautious approach, or growth moderates from here.

The Bank of Canada and European Central Bank were among the central banks that decided to continue interest rate cuts in January. But in the U.S., where the labor market and economic growth appear stronger, the Federal Reserve decided to pause, keeping a relatively restrictive stance on policy. However, additional cuts remain expected in the quarters ahead.

Stocks outperformed bonds, regaining momentum after a weak end to 2024. Given the backdrop, markets displayed strong breadth in January, with all asset classes grinding higher. After hitting peaks not seen in over a year, long-term interest rates began to drift lower. This helped ease some pressure on stock and bond allocations.

International large-cap stocks performed best, but U.S. stocks weren’t far behind. Some stock indexes across U.S. and international developed markets hit new all-time highs. All three U.S. stock asset classes have maintained their leadership position over the year and regained some momentum after meaningfully underperforming in December.

Despite the month’s broad gains, not all markets have climbed back from their losses in recent periods. Cash-like investments and higher-quality bonds underperformed in January, as they have over the past 12 months.

While higher interest rates have helped bondholders generate higher income, U.S. investment-grade bond returns remain negative over three- and five-year periods, given the pressure of rising rates on bond prices over those time frames.

Volatility ticked higher amid walls of worry but remained largely contained in January. As with any year, 2025 hasn’t come without its pockets of uncertainty and market-moving headlines.

A Chinese startup, DeepSeek, announced it had developed highly competitive artificial intelligence (AI) technology at a relatively lower cost. This caused investors to question whether elevated valuations within U.S. tech stocks were justified, leading to negative returns within the sector. And tariff threats from the new U.S. presidential administration picked up steam toward month-end, causing weakness across markets.

Markets have also demonstrated sensitivity to broader shifts in global policies, ongoing stickiness within inflation data, and evolving monetary policies. But overall, markets ended up climbing higher in January amid these walls of worry. This demonstrates the importance of staying invested despite a return to more normal levels of volatility.

What do we recommend going forward?

Protect against concentration risks, particularly following uneven market performance. Stocks have performed well in recent years, with some equity asset classes rising by more than 10% annually, on average, over the past five years. Higher-quality U.S. bonds, on the other hand, have generally fallen over the same time frame.

More specifically, U.S. mega-cap tech stocks have been among the strongest-performing investments over this period. As such, in the past five years, the top 10 names in the S&P 500 have grown from less than 25% to over 35% of the index. Given their heavy weighting, the performance of this small set of stocks is a key driver of the index’s performance overall, increasing its concentration risks.

Similar dynamics can impact portfolio allocations and performance as well. If left unchecked, these lopsided market returns can cause your portfolio to drift too far from your intended targets. This can increase the risk that it may not perform in alignment with your financial goals.

Disciplined rebalancing strategies help keep the focus of your portfolio on your goals during periods of uncertainty and uneven asset class performance. Well-diversified, strategic allocations are designed to help you achieve your risk and return objectives. Keep these long-term targets in sight when incorporating timely investment opportunities or rebalancing your portfolio.

Broadening markets strengthen the case for broader portfolio diversification. Broadening market leadership — as displayed across sectors, regions and market capitalizations in January — is a key theme we expect to play out through 2025. Furthermore, broadening a portfolio’s diversification may help navigate periods of uncertainty by smoothing fluctuations.

We recognize the growth potential of AI technologies and the investment opportunities it creates for well-diversified portfolios. Quality stocks within mega-cap tech have delivered solid earnings growth and carry strong balance sheets.

But January’s headlines, along with their relatively lofty valuations, demonstrate these growth-style stocks aren’t immune to volatility. Therefore, it’s important to recognize investment opportunities more broadly, as well as the diversification benefits they can provide.

For example, financials and industrials, among other more value-oriented sectors, have shown strength recently. The increased likelihood for pro-growth policies and deregulatory shifts have helped expected earnings growth within value stocks to display catch-up potential, which could help broaden markets further. Their lower valuations also support the case to maintain neutral allocations between value- and growth-style stocks. A similar case can be made to add small- and mid-cap allocations alongside their large-cap peers in a well-diversified portfolio.

Stocks — especially U.S. stocks — appear more attractive than bonds in this environment. We favor reallocating toward U.S. large- and mid-cap stocks from U.S. investment-grade bonds and, as of last quarter, international developed-market stocks across market capitalizations.

The U.S. economy has displayed enduring strength, and tailwinds from potential for pro-growth policies, Fed rate cuts and rising corporate profits support ongoing leadership within U.S. stocks, even if gains moderate or volatility rises. Broadening market leadership beyond mega-cap tech stocks can further propel momentum within U.S. stocks, particularly over developed international alternatives, which face weaker growth prospects, greater trade policy headwinds and a strong dollar.

While higher interest rates have increased the attractiveness of bonds, the potential for price appreciation within U.S. investment-grade bond allocations may be limited. If economic growth remains sound as we expect, and inflation settles in the 2%–3% range, long-term interest rates may remain range-bound.

However, with interest rates toward the high end of our expected range and additional central bank rate cuts likely in the months ahead, we believe investors should consider reducing overweight cash and short-term bond allocations in favor of quality, intermediate-term bonds.

These moves, along with our recommendation to consider overweighting emerging-market debt over U.S. high-yield bonds, are designed to help portfolios benefit from this interest rate environment and position portfolios for the months ahead.

We’re here for you

Volatility is a normal part of investing, strengthening the case for diversification. Walls of worry and daily headlines can cause distractions, but maintaining appropriate performance expectations and a disciplined approach to investing can help keep emotions in check.

Talk with your financial advisor about our diversification guidance and its benefits. They can help incorporate timely market opportunities while helping ensure your portfolio remains aligned with your financial goals.

If you don’t have a financial advisor and would like help strengthening your portfolio’s diversification and connection to your financial goals, we invite you to meet with an Edward Jones financial advisor.

Strategic portfolio guidance

Defining your strategic investment allocations helps to keep your portfolio aligned with your risk and return objectives, and we recommend taking a diversified approach. Our long-term strategic asset allocation guidance represents our view of balanced diversification for the fixed-income and equity portions of a well-diversified portfolio, based on our outlook for the economy and markets over the next 30 years. The exact weightings (neutral weights) to each asset class will depend on the broad allocation to equity and fixed-income investments that most closely aligns with your comfort with risk and financial goals.

Diversification does not ensure a profit or protect against loss in a declining market.

 Strategic asset allocation guidance
Source: Edward Jones.

Opportunistic portfolio guidance

Our opportunistic portfolio guidance represents our timely investment advice based on current market conditions and a shorter-term outlook. We believe incorporating this guidance into a well-diversified portfolio may enhance your potential for greater returns without taking on unintentional risks, helping keep your portfolio aligned with your risk and return objectives. We recommend first considering our opportunistic asset allocation guidance to capture opportunities across asset classes. We then recommend considering opportunistic equity style, U.S. equity sector and U.S. investment-grade bond guidance for more supplemental portfolio positioning, if appropriate.

 Opportunistic asset allocation guidance
Source: Edward Jones.
 Opportunistic equity style guidance
Source: Edward Jones
 Opportunistic equity sector guidance
Source: Edward Jones
 Opportunistic U.S. investment-grade bond guidance
Source: Edward Jones

Tom Larm, CFA®, CFP®

Tom Larm is a Portfolio Strategist on the Investment Strategy team. He is responsible for developing advice and guidance related to portfolio construction, asset allocation and investment performance to help clients achieve their long-term financial goals.

Tom graduated magna cum laude from Missouri State University with a bachelor’s degree in finance. He earned his MBA from St. Louis University, is a CFA charterholder and holds the CFP professional designation. He is a member of the CFA Society of St. Louis.

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Important information

Past performance of the markets is not a guarantee of future results.

Investing in equities involves risk. The value of your shares will fluctuate, and you may lose principal. Mid- and small-cap stocks tend to be more volatile than large-company stocks. Special risks are involved in international and emerging-market investing, including those related to currency fluctuations and foreign political and economic events.

Diversification does not ensure a profit or protect against loss in a declining market.

Rebalancing does not guarantee a profit or protect against loss and may result in a taxable event.

Before investing in bonds, you should understand the risks involved, including credit risk and market risk. Bond investments are also subject to interest rate risk such that when interest rates rise, the prices of bonds can decrease, and the investor can lose principal value if the investment is sold prior to maturity. High-yield bonds carry a high risk of principal loss and may experience more price volatility than investment-grade bonds. Emerging-market bonds are riskier than bonds from more developed countries.

The opinions stated are for general information purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation.