Three bets on stock and bond markets investors might regret

Key takeaways

• We anticipate volatility to continue, suggesting additional focus on diversification and risk management.
• Volatility can create opportunity: We have seen managers capitalize on dispersion across stock and bond markets.
• Advisor portfolio biases may be driving underperformance this year: an overweight to small caps, underweight to international assets and overweight cash could limit upside.

It’s been a roller coaster of a year so far, and we’re not even halfway through. The S&P 500 has moved by 2% or more on 12 trading days this year, with the big moves equally split between positive and negative days.¹

Volatility has calmed since peaking in April, but we may not be out of the woods yet. This year has reminded us of the importance of staying invested, staying diversified and being nimble in taking advantage of opportunities.

Here’s how our asset allocators are trying to navigate these choppy waters: We favor equities, but have less conviction in active regional exposures, leaning on security selectors to try to capture higher dispersion. We are concerned about the outlook for longer-term bonds and are seeking additional forms of diversification that can be less sensitive to interest rates.

Three misplaced bets advisors are making

There are three big bets advisors have been making that could challenge performance going forward. BlackRock managers are positioning differently.

Let’s review each bet:

The average advisor is overweight small caps vs. the broad market

Small caps have had a challenging run. After rallying in late 2024 on optimism around falling interest rates and potentially lower taxes, the Russell 2000 Small Cap Index fell 27% between November 25^th and April 8^th.²

Small caps may have a difficult path ahead. If growth stays resilient, the Fed may not cut rates, leaving smaller cap companies to pay more in interest expense (roughly half of small cap debt is either floating rate or maturing in the next two years).³ But if growth slows meaningfully, the benefits from lower interest rates may be offset by smaller caps’ greater sensitivity to economic downturns.

For those reasons, our Target Allocation model portfolios team continues to underweight this space, and instead prefers to seek outperformance through large caps.

One strategy to consider is the iShares Thematic Rotation Active ETF (THRO), which aims to dynamically rotate across U.S. market themes the portfolio managers believe could drive performance. The top theme today is consumers tightening their belts: Portfolio managers are investing in the budget retailers, department stores, consumer staples and grocers that could benefit from consumers focusing on the essentials amid slowing growth.

The “consumer” basket of THRO has outperformed traditional sector indexes, benefiting from weakening consumer sentiment earlier this year.

Dispersion across stocks creates opportunity for active manager
Cumulative returns for THRO consumer basket vs. sector indexes, Nov 2024-April 2025

The average advisor may not have enough international exposure

The more uncertain markets are, the more diversification can help balance out risks.

International equities – as represented by the MSCI EAFE Index – are beating the S&P 500 by 16% YTD through May.⁴ But the average advisor is underweight, with just 21% of the average equity portfolio allocated to international equities (versus the MSCI ACWI’s 36%).

Tailwinds, including the possibility of more dovish global central banks, higher defense and infrastructure spending in Europe and potentially re-wired supply chains could all support a higher allocation to international equities. In fact, our Target Allocation model portfolios team recently reduced its underweight to international equities in its models that hold equities. 

We see a similar under-allocation in international bonds: The average advisor allocates 15% of their fixed income sleeve here, but international bonds make up 59% of the global bond universe.⁵ The Bloomberg Global Aggregate ex USD Index is beating the Bloomberg U.S. Aggregate Bond Index’s U.S. bonds by over 5% YTD through May.⁶ Our portfolio managers think we could see more upside in this space, since a slower growth and lower inflation outlook could support international bond performance.

The average advisor may hold too much cash

Volatile bond markets may have driven many advisors to seek out safety in cash. Longer-term Treasuries have certainly been under pressure – 20+ year treasuries have meaningfully underperformed shorter tenors – but an over-allocation to cash may be leaving money on the table.

Long bonds have been under pressure 
YTD performance of U.S. treasury indexes (%)

Our teams have been seeking to build in ballast through a mix of flexible fixed income strategies that can dynamically position along the curve and alternative strategies with low correlations to stocks and bonds. As an example, nearly half of the “40” of the Target Allocation Hybrid with Alts 60/40 portfolio is allocated to liquid alternative strategies.

Some alternative strategies – such as the BlackRock Global Equity Market Neutral Fund (BDMIX) – have been able to take advantage of security dispersion and high cash rates. BDMIX has outperformed the S&P 500 by 8% YTD through 5/31, with less than 1/3 of the volatility.⁷

Performance data represents past performance and does not guarantee future results. Investment return and principal value will fluctuate with market conditions and may be lower or higher when you sell your shares. Current performance may differ from the performance shown. For most recent month-end performance and standardized performance, click here. 

And indeed, when we polled advisors on the May 29^th “In the Know” webinar, 39% cited cash as the position they were most likely to reduce in the next 3-6 months, in favor of adding to international equities (43%), alternatives (42%) or U.S. equities (35%).⁸

Portfolio considerations as we enter summer

• Revisit your equity allocation: International stocks have had lower correlations to large cap U.S. equities than domestic small caps, and have a lower standard deviation of returns. Those still overweight small caps may want to consider diversifying abroad instead.
• Consider your active/indexed blend and ensure that your active managers are delivering. Today’s higher dispersion could create opportunity for active managers to deliver higher alpha.
• Expand beyond long bonds for diversification. Assets with low correlations to equities are in short supply, but are critical portfolio components when risk spikes. Expand your diversifier universe to include alternatives and seek out managers that have been able to maintain low correlations to traditional asset classes while delivering consistent returns.

BlackRock can help you construct well-diversified portfolios designed for today’s markets. Contact your BlackRock representative for more information or explore our online investment tools and resources.

Explore the Advisor Outlook – BlackRock’s monthly market outlook for financial advisors – for more details on our latest market and portfolio insights.

Advisor Outlook

Aaron Task, Erin Manifase, Faye Witherall, and Ben Wallach contributed to this article.

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