Diversification mirage in plain sight
Market take
Weekly video_20251215
Natalie Gill
Portfolio Strategist, BlackRock Investment Institute
Opening frame: What’s driving markets? Market take
Camera frame
With only a handful of mega forces driving returns, we think there is no such thing as a neutral portfolio allocation. And rising bond yields across developed market economies mean traditional diversifiers like long-term Treasuries offer less portfolio ballast than they once did. Instead, this environment calls for being dynamic and seeking unique sources of return.
Title slide: Diversification mirage in plain sight
1: A powerful common driver
For several years now, we’ve laid out how the economic transformation mega forces were driving challenged traditional methods of diversification. We’re seeing that play out now. Trying to diversify away from the US or the AI mega force towards other regions or equal-weighted indices amount to larger active calls than before. In fact, our analysis shows that – after accounting for factors that typically explain equity returns – a growing share of US stock returns are tied to a single, common driver.
We think investors should focus less on spreading risk indiscriminately and more on owning it deliberately – in short, a more active approach. We also think portfolios need a clear plan B and a readiness to pivot quickly.
2: Spiking bond yields
Another illustration of the diversification mirage? The spike in developed market bond yields over the last several weeks – underscoring our view that long-term bonds don’t help balance portfolios as they once did. The surge is partly due to heightened concerns around loose fiscal policy and deteriorating fiscal outlooks. Japanese 30-year bond yields hit record highs earlier this month and are up more than 100 basis points this year. The latest move up was triggered by a Japanese government fiscal spending package, as well as the Bank of Japan signaling a potential rate hike this week. Central banks in countries like Australia and Canada have shifted their tone on rates – either flagging an end to cuts or a potential hike.
3: Global monetary policy disconnect
We see a growing disconnect between the US and other central banks going into next year. The US has stronger growth and inflation, but is taking a more dovish approach. By contrast, these other developed markets are facing weaker growth with more hawkish central banks. We’re eyeing this contrast as a risk heading into next year.
We’re also watching upcoming US data in the aftermath of last week’s Federal Reserve interest rate decision, the most disputed since 2019 with three dissents. We think the Fed is erring on the side of being too easy even with the division. Any rebound in hiring or business confidence could reignite inflation pressures and bring back policy tensions with debt sustainability.
Outro: Here’s our Market take
We see the diversification theme from our full-year outlook unfolding now. We think this environment calls for seeking truly unique return sources – such as in private markets and hedge funds – as a distinct allocation for alpha. We stay pro-risk on the AI theme.
Closing frame: Read details: blackrock.com/weekly-commentary
Outlook themes in real time
We see the diversification mirage – one of our 2026 Outlook themes – playing out in real time with a sharp spike in global bond yields.
Market backdrop
The Nasdaq lost 2% as AI-linked capital spending concerns hurt tech stocks. US 10-year yields hit a three-month high amid a global bond selloff.
Week ahead
We see the potential for a Bank of Japan rate hike and Bank of England rate cut. Delayed US inflation and jobs data are likely to be noisy.
We see the diversification mirage theme in our 2026 Outlook playing out in real time: rising developed market bond yields underscore our view that traditional diversifiers like long-term Treasuries offer diminished portfolio ballast. The importance of the AI theme illustrates why a “neutral” portfolio allocation doesn’t exist when only a handful of mega forces are driving returns. We think this environment calls for being dynamic and seeking unique return sources.
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A powerful common driver
Variance in S&P 500 returns explained by a dominant underlying factor
Source: BlackRock Investment Institute, with data from Bloomberg and Kenneth R. French, December 2025. Note: The line shows the variance of daily S&P 500 stock returns explained by a common driver after accounting for equity style actors like value, and momentum. This was calculated using first principal component of principal component analysis over a rolling 252-day window. The first principal tries to capture a common driver of stock returns.
For a few years, we have laid out how the economic transformation of mega forces challenged traditional methods of portfolio diversification. In this environment, efforts to diversify away from the US or the AI mega force amount to larger active calls than before. Our analysis shows that after accounting for factors that typically explain equity returns, a growing share of US stock returns are tied to a single, common driver. See the chart. We think investors should focus less on spreading risk indiscriminately and more on owning it deliberately – in short, a more active approach. We also think portfolios need a clear plan B and readiness to pivot quickly. Another illustration of the diversification mirage? Spiking developed market bond yields in recent weeks. This underscores our view that traditional diversifiers like long-term bonds do not offer the portfolio ballast they once did.
The surge in long-term bond yields is partly due to heightened market concerns about loose fiscal policy and deteriorating fiscal outlooks. Japanese 30-year bond yields hit record-highs earlier this month and are up more than 100 basis points this year. The latest move up was triggered by a Japanese government fiscal spending package, as well as the Bank of Japan signaling a potential rate hike this week. Central banks in Australia and Canada have also shifted their tone on rates – either flagging an end to cuts or the potential for a hike.
A powerful common driver
We think the US disconnect with other central banks is a risk heading into next year. The US has stronger growth and inflation but is taking a more dovish stance, while these economies face weaker data with more hawkish central banks. We already see the Fed erring on the side of being too easy even with the divisions among Fed policymakers. Long-term Treasury yields can rise further if investors demand more premium for the risk of holding them, so we prefer short-term Treasuries in this environment. Any rebound in hiring or a rise in business confidence could reignite inflation pressures and bring back policy tensions with debt sustainability. This puts a spotlight on this week’s US data, especially when the release of economic data starts to normalise in January. We think the delayed October payrolls data this week could show a contraction, reflecting deferred government layoffs. These figures could also be noisy due to the difficulties of collecting data during the government shutdown as Fed Chair Jerome Powell noted last week.
We are in a more challenging environment for diversification, favoring a dynamic approach. We think this environment calls for seeking truly idiosyncratic return sources - such as in private markets and hedge funds - as a distinct allocation for earning alpha in portfolios.
Our bottom line
We see the diversification mirage theme from our full-year outlook unfolding now. This environment calls for a dynamic approach with a plan B. We stay pro-risk on the AI theme and prefer unique exposures for portfolio ballast.
This is our final edition for 2025. Happy holidays to all, and the Weekly commentary will return on Monday, Jan. 5.
Market backdrop
Tech stocks slid on a sharp drop in AI names Broadcom and Oracle over larger capital spending plans and thinner profit margins. The Nasdaq shed about 2% on the week, while the S&P 500 lost nearly 1% but was not far from all-time highs. The Fed penciled in another cut in 2026, reinforcing our view that it will err on the side of keeping policy too easy next year. US 10-year Treasury yields rose to three-month highs near 4.20%, while long-term yields surged elsewhere.
2025 winds down with a busy week of central bank meetings. We see the potential for a Bank of Japan rate hike; expect the Bank of England to cut; and think the European Central Bank will hold rates steady, even as it turns more hawkish. We look to global inflation data to shed light on central banks’ positioning going into 2026 and eye US payrolls to see if the softer labor market that has allowed the Fed to cut persisted during the data blackout.
Week ahead
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of December 11, 2025. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in US dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE US Dollar Index (DXY), spot gold, spot bitcoin, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (US, Germany and Italy), Bloomberg Global High Yield Index, J.P. Morgan EMBI Index, Bloomberg Global Corporate Index and MSCI USA Index.
Dec. 16
Global flash PMIs; US Oct. and Nov. payrolls
Dec. 17
UK Nov. CPI
Dec. 18
US Nov. CPI; European Central Bank and Bank of England policy decisions
Dec. 19
Japan Nov. CPI; Bank of Japan policy decision
Read our past weekly commentaries here.
Big calls
Our highest conviction views on six- to 12-month (tactical) and over five-year (strategic) horizons, December 2025
| Reasons | ||
|---|---|---|
| Tactical | ||
| Still favor AI | We see the AI theme supported by strong earnings, resilient profit margins and healthy balance sheets at large listed tech companies. Continued Fed easing into 2026 and reduced policy uncertainty underpin our overweight to US equities. | |
| Select international exposures | We like Japanese equities on strong nominal growth and corporate governance reforms. We stay selective in European equities, favoring financials, utilities and healthcare. In fixed income, we prefer EM due to improved economic resilience and disciplined fiscal and monetary policy. | |
| Evolving diversifiers | We suggest looking for a “plan B” portfolio hedge as long-dated US Treasuries no longer provide portfolio ballast – and to mind potential sentiment shifts. We like gold as a tactical play with idiosyncratic drivers but don’t see it as a long-term portfolio hedge. | |
| Strategic | ||
| Portfolio construction | We favor a scenario-based approach as AI winners and losers emerge. We lean on private markets and hedge funds for idiosyncratic return and to anchor portfolios in mega forces. | |
| Infrastructure equity and private credit | We find infrastructure equity valuations attractive and mega forces underpinning structural demand. We still like private credit but see dispersion ahead – highlighting the importance of manager selection. | |
| Beyond market cap benchmarks | We get granular in public markets. We favor DM government bonds outside the US Within equities, we favor EM over DM yet get selective in both. In EM, we like India which sits at the intersection of mega forces. In DM, we like Japan as mild inflation and corporate reforms brighten the outlook. | |
Note: Views are from a US dollar perspective, December 2025. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security.
Tactical granular views
Six- to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2025
We have lengthened our tactical investment horizon back to six to 12 months. The table below reflects this and, importantly, leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns – especially at a time of heightened volatility.
| Asset | Tactical view | Commentary | ||||
|---|---|---|---|---|---|---|
| Equities | ||||||
| United States |  |
We are overweight. Strong corporate earnings, driven in part by the AI theme, are supported by a favorable macro backdrop: continued Federal Reserve easing, broad economic optimism and less policy uncertainty, particularly on the trade front. | ||||
| Europe |  |
We are neutral. We would need to see more business-friendly policy and deeper capital markets for recent outperformance to continue and to justify a broad overweight. We stay selective, favoring financials, utilities and healthcare. | ||||
| UK | |
We are neutral. Valuations remain attractive relative to the US, but we see few near-term catalysts to trigger a shift. | ||||
| Japan | |
We are overweight. Strong nominal GDP, healthy corporate capex and governance reforms – such as the decline of cross-shareholdings – all support equities. | ||||
| Emerging markets | |
We are neutral. Economic resilience has improved, yet selectivity is key. We see opportunities across EM linked to AI and the energy transition and see the rewiring of supply chains benefiting countries like Mexico, Brazil and Vietnam. | ||||
| China | |
We are neutral. Trade relations with the US have steadied, but property stress and an aging population still constrain the macro outlook. Relatively resilient activity limits near-term policy urgency. We like sectors like AI, automation and power generation. We still favor China tech within our neutral view. | ||||
| Fixed income | ||||||
| Short US Treasuries | |
We are neutral. We see other assets offering more compelling returns as short-end yields have fallen alongside the US policy rate. | ||||
| Long US Treasuries |  |
We are underweight. We see high debt servicing costs and price-sensitive domestic buyers pushing up on term premium. Yet we see risks to this view: lower inflation and better tax revenues could push down yields near term. | ||||
| Global inflation-linked bonds | |
We are neutral. We think inflation will settle above pre-pandemic levels, but markets may not price this in the near-term as growth cools. | ||||
| Euro area government bonds | |
We are neutral. We agree with market forecasts of ECB policy and think current prices largely reflect increased German bond issuance to finance its fiscal stimulus package. We prefer government bonds outside Germany. | ||||
| UK Gilts | |
We are neutral. The recent budget aims to shore up market confidence through fiscal consolidation. But deferred borrowing cuts could bring back gilt market volatility. | ||||
| Japanese government bonds |  |
We are underweight. Rate hikes, higher global term premium and heavy bond issuance will likely drive yields up further. | ||||
| China government bonds | |
We are neutral. China bonds offer stability and diversification but developed market yields are higher and investor sentiment shifting towards equities limits upside. | ||||
| US agency MBS | |
We are overweight. Agency MBS offer higher income than Treasuries with similar risk and may offer more diversification amid fiscal and inflationary pressures. | ||||
| Short-term IG credit | |
We are neutral. Corporate strength means spreads are low, but they could widen if issuance increases and investors rotate into US Treasuries as the Fed cuts. | ||||
| Long-term IG credit | |
We are underweight. We prefer short-term bonds less exposed to interest rate risk over long-term bonds. | ||||
| Global high yield | |
We are neutral. High yield offers more attractive carry in an environment where growth is holding up – but we think dispersion between higher and weaker issuers will increase. | ||||
| Asia credit | |
We are neutral. Overall yields are attractive and fundamentals are solid, but spreads are tight. | ||||
| Emerging hard currency | |
We are overweight. A weaker US dollar, lower US rates and effective EM fiscal and monetary policy have improved economic resilience. We prefer high yield bonds. | ||||
| Emerging local currency | |
We are neutral. A weaker US dollar has boosted local currency EM debt, but it’s unclear if this weakening will persist. | ||||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a US dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Euro-denominated tactical granular views
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, December 2025
| Asset | Tactical view | Commentary | ||
|---|---|---|---|---|
| Equities | ||||
| Europe ex UK | |
We are neutral. We would need to see more business-friendly policy and deeper capital markets for recent outperformance to continue and to justify a broad overweight. We stay selective, favoring financials, utilities and healthcare. | ||
| Germany | |
We are neutral. Increased spending on defense and infrastructure could boost the corporate sector. But valuations rose significantly in 2025 and 2026 earnings revisions for other countries are outpacing Germany. | ||
| France | |
We are neutral. Political uncertainty could continue to drag corporate earnings behind peer markets. Yet some major French firms are shielded from domestic weakness, as foreign activity accounts for most of their revenues and operations. | ||
| Italy | |
We are neutral. Valuations are supportive relative to peers. Yet we think the growth and earnings outperformance that characterized 2022-2023 is unlikely to persist as fiscal consolidation continues and the impact of prior stimulus peters out. | ||
| Spain | |
We are overweight. Valuations and earnings growth are supportive relative to peers. Financials, utilities and infrastructure stocks stand to gain from a strong economic backdrop and advancements in AI. High exposure to fast-growing areas like emerging markets is also supportive. | ||
| Netherlands | |
We are neutral. Technology and semiconductors feature heavily in the Dutch stock market, but that’s offset by other sectors seeing less favorable valuations and a weaker earnings outlook than European peers. | ||
| Switzerland |  |
We are neutral. Valuations have improved, but the earnings outlook is weaker than other European markets. If global risk appetite stays strong, the index’s tilt to stable, less volatile sectors may weigh on performance. | ||
| UK | |
We are neutral. Valuations remain attractive relative to the U.S., but we see few near-term catalysts to trigger a shift. | ||
| Fixed income | ||||
| Euro area government bonds | |
We are neutral. Yields are attractive, and term premium has risen closer to our expectations relative to US Treasuries. Peripheral bond yields have converged closer to core yields. | ||
| German bunds | |
We are neutral. Potential fiscal stimulus and bond issuance could push yields up, but we think market pricing reflects this possibility. Market expectations for near-term policy rates are also aligned with our view. | ||
| French OATs | |
We are neutral. France faces continued challenges from elevated political uncertainty, high budget deficits and slow structural reforms, but these risks already seem priced into OATs and we don’t expect a worsening from here. | ||
| Italian BTPs | |
We are neutral. The spread over German bunds looks tight given its large budget deficits and growing public debt. Domestic factors remain supportive, with growth holding up relative to the rest of the euro area and Italian households showing solid demand to hold BTPs at higher yields. Domestic political pushback likely prevents defense spending from rising to levels that would resurface fiscal stability concerns. | ||
| UK gilts | |
We are neutral. Gilt yields are off their highs, but we expect more market attention on long-term yields through the government’s November budget, given the difficulty it has had implementing spending cuts. | ||
| Swiss government bonds | |
We are neutral. Markets are expecting policy rates to return to negative territory, which we deem unlikely. | ||
| European inflation-protected securities | |
We are neutral. We see higher medium-term inflation, but inflation expectations are firmly anchored. Cooling inflation and uncertain growth may matter more near term. | ||
| European investment grade | |
We are neutral on European investment grade credit, favoring short- to medium-term paper for quality income. We prefer European investment grade over the US Quality-adjusted spreads have tightened significantly relative to the US, but they remain wider, and we see potential for further convergence. | ||
| European high yield | |
We are overweight. The income potential is attractive, and we prefer European high yield for its more appealing valuations, higher quality and less sensitivity to interest rate swings compared with the US Spreads adequately compensate for the risk of a potential rise in defaults, in our view. | ||
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a euro perspective, December 2025. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Meet the authors
Jean Boivin
Head – BlackRock Investment Institute
Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Glenn Purves
Global Head of Macro – BlackRock Investment Institute
Natalie Gill
Portfolio Strategist – BlackRock Investment Institute
This material is for distribution to Professional Clients (as defined by the FCA Rules) and should not be relied upon by any other persons.
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Sources: Bloomberg unless otherwise specified.
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