Diversify for 2025 – Don't be fooled by déjà vu

As the final quarter of 2025 approaches, investor sentiment is conflicted. Stock indexes are near record highs, thanks to AI-driven earnings growth. However, consumer sentiment remains low, bond markets are no longer acting as a stabilizing factor, and geopolitical tensions remain, albeit at a steady low level. In other words, we feel like we're experiencing the best of times and the worst of times simultaneously, as Charles Dickens wrote.

In a nutshell:

• Diversification 2.0 – As the classic 60/40 model has lost its effectiveness and market volatility is likely to remain high, investors need to think differently and supplement their investment portfolio with assets other than stocks and bonds.
• Stocks are the main source of growth "Investment opportunities remain, but the dominance of American technology companies means you need to choose your investments more carefully. To strengthen your portfolio, it's also worth investing in stocks from European, Asian, and small-cap companies."
• Don't try to predict the future - prepare for it– Build portfolio resilience by investing in high-quality stocks, ensuring stable income from medium-term bonds, and treating gold as a key portfolio stabilizer.

“Diversification is not a matter of having more, but of having differently.”

For investors, the challenge isn't predicting which version of reality will come true, but ensuring their portfolios are stable across each. This is where diversification comes into play. However, the classic definition of diversification—a simple mix of stocks and bonds—is losing its effectiveness. The correlation between stocks and bonds has become stronger as a large portion of profits is concentrated in the hands of American giants, leaving many investment portfolios overly exposed to risk. Furthermore, years of cheap credit have made it more difficult to assess which risks are actually worth taking.

This quarter requires a new approach. Let's call it "diversification 2.0."

Why the traditional 60/40 model no longer protects

For decades, a portfolio consisting of 60% stocks and 40% bonds was considered the gold standard of equilibrium: when stocks fell, bonds typically rose, mitigating losses. However, this relationship has weakened. High inflation and high public debt mean that bonds often move in the same direction as stocks, amplifying risk rather than neutralizing it.

The lesson is clear: diversification today isn't just about holding more assets, but the right assets. Investors need to look at the bigger picture—across regions, sectors, and risk factors—rather than assuming that past hedges will hold in the future. With markets in economic distress, unresolved political and trade issues in the US, and rising geopolitical risks, volatility is likely to remain elevated through the end of the year.

"Diversification beats déjà vu. The point now isn't to miss out on what worked, but to avoid being overexposed to it."

Stocks: Range, Value, and Profit Confirmation

Stocks remain a key component of investment portfolios, but risks remain: US company valuations are overvalued, AI-related outcomes are uncertain, and geopolitical tensions could escalate unexpectedly. Stocks still offer opportunities, but require greater selectivity.

The US stock market is still the global benchmark, but its dominance has narrowed significantly. A small group of tech and AI giants have driven performance, while the rest of the market has lagged. This creates both concentration and valuation risks.

The AI ​​Revolution It's still a strong growth engine, but the market has moved into its second phase. The first wave of AI winners—semiconductor manufacturers, energy suppliers, data centers—have already delivered extraordinary profits. However, expectations are running ahead of results, and the next phase will require proof: which companies can make AI generate real revenue?

This is becoming a two-pronged AI story: the US remains the leader, while China is catching up in its own market, focusing on scale and efficiency, supported by policy. Both markets offer opportunities, but in very different ways.

"AI excitement without delivered results is just a temporary boost. Financial results are the true test of sustainability."

Europe stands out in this context. Valuations remain significantly lower than in the US, even as governments begin to implement significant fiscal policy changes, directing spending toward defense, infrastructure, and energy independence. After a weaker 2025, performance is expected to improve in 2026, supported by monetary easing and fiscal support.

Asia also shows promise. Japanese companies continue to benefit from corporate governance reforms and a shareholder-friendly approach, transforming what was once considered a value trap into a more compelling growth story.

China remains in a complex situation. While its real estate sector continues to face significant headwinds and regulations remain unpredictable, China is the world's second-largest economy and a global leader in electric vehicles, renewable energy, and advanced manufacturing. Selectivity is key for investors: broad exposure to the entire market carries risks, while targeted investments in China's "new economy" sectors can offer growth potential lacking in other regions.

Developing East Asia—from India's digital boom to Taiwan and Korea's dominance in AI hardware—is also underrepresented in global indices, but offers access to sectors that are unavailable in Western markets. For example, the MSCI World Index assigns only about 8% to developed Asia and excludes China, India, Taiwan, or Korea, even though Asia accounts for about 40% of global GDP.

India deserves special mention. Despite tariff tensions and high valuations, a combination of digitalization, demographics, and stable banks keeps the country's earnings outlook solid. Maintaining investment in India is crucial, focusing on sectors related to domestic demand while also keeping an eye on exporters more exposed to global economic headwinds.

Small-cap stocks also deserve a closer look. Small companies in the US, especially profitable ones represented in the S&P 600 Index, are trading at a lower valuation compared to larger companies. Falling borrowing costs in 2026 and the resilience of domestic demand could allow these companies to experience an above-average recovery. However, investing in small companies carries higher risk, as broad indexes like the Russell 2000 contain many unprofitable companies. Therefore, focusing on high-quality, profitable companies is crucial.

Bonds for Income, Gold for Stability

Bonds have returned to the investment scene, but they no longer serve the same role as a hedge as they once did. They should now be viewed primarily as a source of stable income. The sweet spot on the yield curve is bonds with maturities between three and seven years. These securities offer attractive yields without the sharp fluctuations typical of long-term bonds, which are more vulnerable to inflation surprises and government borrowing. For investors, this segment of the market offers a practical way to generate income while maintaining controlled risk.

As bonds become less reliable as a buffer against market shocks, investors also need stabilizers that behave differently. Gold has once again strengthened its position, reaching record highs this year. Faced with high debt levels and the lower reliability of traditional bond collateral, it stands out as one of the few assets that consistently protects portfolios across a variety of scenarios. Silver i platinum, supported by industrial demand, provide additional diversification.

Risks? Inflation could prove more persistent than expected, keeping yields higher for longer, limiting bond returns. However, if real yields remain positive and markets remain calm, gold could lag equities. However, with anticipated interest rate cuts, cash yields will decline, while intermediate-term bonds and gold could become increasingly attractive as portfolio foundations.

New investor strategy – five key bets for Q4

So what is diversification 2.0 in practice? Here are five key bets for Q4.

Europe

Europe is launching a massive investment program in defense, energy independence, and infrastructure. Valuations are lower than in the US, and investors worldwide are under-invested. After a weaker 2025, performance is expected to improve in 2026, supported by monetary easing and fiscal support. The risks are that a stronger euro or weaker global demand could impact earnings, and that political will for further fiscal expansion could weaken.

How to gain exposure: by investing in broad-based European equity funds or ETFs, with a focus on the industrials, financials and infrastructure sectors.

Asia (China, Japan, India)

Asia continues to be a global growth engine and has a solid earnings foundation for 2026. Japan is implementing corporate governance reforms and increasing shareholder returns. India is combining rapid digitalization with favorable demographic trends. China still carries risks, but selective exposure to technology, electric vehicles, and green industries offers opportunities for profit. East Asia also plays a key role in the global AI supply chain, from chipmakers in Taiwan to memory leaders in Korea—areas that are often underrepresented in global indicators. The main risk is political and regulatory uncertainty, which can change rapidly.

How to gain exposure: Invest in regional Asian funds (excluding Japan), as well as targeted country funds for Japan and India. For China, it's worth choosing diversified investment vehicles focused on "new economy" sectors.

Small companies

Smaller companies underperformed during the high interest rate period, but many are now cheap compared to larger companies. Earnings could improve if borrowing costs fall, although small companies are more vulnerable to ratings downgrades if market conditions deteriorate. They offer exposure to domestic economies, not just global giants. It's crucial to focus on high-quality, profitable companies, rather than broad indices that include unprofitable companies.

How to gain exposure: By investing in US small-cap indices such as the S&P 600 (with qualitative filters), or in global small-cap funds that select companies based on profitability.

Bonds in the "middle of the curve"

Interest rates remain high but are likely to decline in the coming year. The most attractive portion of the bond market is those with maturities between three and seven years. These securities offer stable income while avoiding the volatility of long-term bonds. The risk is that inflation may prove more persistent than anticipated, keeping yields higher for an extended period.

How to gain exposure: By investing in high-quality government and corporate bond funds or ETFs focused on bonds with maturities of 3-7 years.

Real assets – especially gold

As bonds become less reliable as a portfolio protection tool, real assets are playing a more significant role. Gold has once again established itself as a stabilizer, benefiting both in times of crisis and during periods of high inflation. The risk is that if real yields remain high and markets remain calm, gold could lag behind equities.

How to get exposure: ETFs based on physical gold, diversified commodity funds or a small direct allocation to gold bars/coins.

Diversification as a recipe for survival

Diversification is often taken for granted, but in 2025, it's no longer just a sensible strategy—it's a matter of survival. In the coming months, we could experience a mild economic slowdown, a return to inflation, or an unexpected geopolitical shock. No one knows which scenario will unfold, but investors can prepare by diversifying not only across assets but also across risk sources.

This is what diversification 2.0 does: investing in AI companies with a proven track record, the stable yield of medium-term bonds, and the resilience of gold. It's crucial that portfolios are built to withstand not only the next quarter but also the coming crisis.

About the Author

Jacob Falkencrone, Chief Investment Strategist, Saxo Bank. JHe is passionate about creating engaging and educational content that empowers investors to make informed financial decisions. With expertise in portfolio construction, investment strategies, macroeconomics, and market dynamics, Jacob specializes in transforming complex financial concepts into clear, actionable insights tailored to investors at all levels. As a proponent of the democratization of investing, he is dedicated to inspiring confidence and enabling smarter investing through effective communication.