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2025 Midyear Update

By Touchstone Asset Allocation Committee
Economy & Markets
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2025 TAAC Midyear Update

Key Points

  • Lessons from the first half include the importance of diversification, continued economic resilience, and careful evaluation of both short-term impacts and potential longer term consequences of executive actions.
  • We favor fixed income for its portfolio ballast and income generation.
  • We have shifted toward a more diversified approach to our equity exposure as we see a more even playing field across geographies.

Download 2025 Midyear Update (PDF)

First Half Lessons: Humility and Patience

Markets so far in 2025 have been a masterclass in volatility, driven by policy pivots, trade turbulence, and shifting economic signals. The post-Liberation Day rebound brought a wave of investor optimism, but deeper uncertainties remain. Through it all, several key investment lessons have come into sharper focus:

  1. Don’t Underestimate the Resilience of the U.S. Economy
    Despite a restrictive Fed and repeated recession forecasts, the economy continues to grow. Consumer demand remains sturdy, the labor market is largely balanced, and earnings have broadly exceeded expectations. Investors who stayed grounded in fundamentals and avoided reacting to every negative headline were rewarded for their patience.
  2. Executive Power Is Now a Market Force And It’s Unpredictable
    Perhaps the most underappreciated lesson of the year is just how central the executive branch has become to market dynamics. The Trump administration’s use of executive action, most notably the rollout and subsequent pause of Liberation Day tariffs, has created real time policy whiplash. The ability to unilaterally impose or reverse major economic measures has injected significant headline risk into markets.
    But there's a design to the approach, too: the administration appears intent on reshaping trade and industrial policy, but not at the cost of the economy, or the GOP’s electoral prospects. Investors must now weigh not only policy content, but also political timing. Markets are being shaped as much by polling calculus as by macro fundamentals.
  3. Diversification Matters Most When Uncertainty Rises
    Leadership has rotated rapidly across regions and sectors. While thematic or concentrated strategies can shine briefly, a diversified approach provided ballast during market dislocations and allowed portfolios to participate in unexpected rebounds. Diversification remains one of the best defenses against an unknowable future.

The Economy: Slower, Not Stalled

Looking ahead to the second half, we expect economic growth to slow, but we don’t see a significant risk of recession, absent a major crisis. The U.S. economy still benefits from solid household and corporate balance sheets and moderate job growth, though there is evidence that tighter financial conditions are starting to bite.

Over the medium term, we believe the economy is capable of settling into a central tendency of around 2% real GDP growth. This outlook reflects a blend of factors, slower labor force growth given immigration policy, headwinds from lingering tariffs, and the potential for higher productivity from AI adoption.

US Real GDP Growth 2018 - 2027 est

On top of this real growth baseline, we expect the Fed will eventually succeed in guiding inflation back toward its 2% target. But doing so may require keeping interest rates higher for longer than markets have been conditioned to expect.

Fixed Income: Bonds are Back

In a world of higher structural rates, bonds are relevant again. Unlike the previous cycle, where yields offered little cushion, today’s fixed income markets provide meaningful income and a reasonable buffer against volatility.

With the Fed unlikely to cut aggressively in the near term, staying invested across quality fixed income sectors offers an attractive balance of income and risk mitigation. Investors no longer have to choose between yield and safety.

10-year Yield Range for Fixed Income Sectors

U.S. Equities: Moderating Returns

We see a more moderate return environment for U.S. equities. Our 4% nominal GDP forecast suggests that revenue growth will be modest. With margins already elevated, there's limited room to boost earnings through operational leverage. Some acceleration in productivity is implied in our estimate due to AI adoption, though we could be underestimating its potential.

Valuations, particularly among large caps, remain rich, trading near dot.com peaks by many measures. The price investors pay continues to be a strong determinant of future returns. Given current high valuations and high profit margins, large cap U.S. equities may deliver more pedestrian returns going forward.

S&P 500 Index Return Composition

There’s more nuance in the small and mid cap space. Near-term risks, especially tied to economic sensitivity, remain elevated. But beyond the immediate horizon, lower starting valuations and less optimized profit margins offer a more favorable setup for long-term outperformance.

International Equities: Leveling the Playing Field

Looking backward from the early 2010s through earlier this year, international equities have underperformed in dollar terms, dragged down by a strengthening greenback and falling valuation multiples. However, looking forward, we don’t believe those headwinds will be as pronounced.

Valuations: US dollar, US versus International Equities

We believe the dollar has peaked due to extended valuations. And the dollar could enter a period of secular decline if the Trump administration introduces policies that dissuade international holdings of U.S. assets. Beyond currency, international markets are trading at a significant discount to U.S. equities. With lower expectations baked into U.S. stocks, the performance bar for international equities has effectively been lowered. We recommend strategic weights to international exposure, both developed and emerging markets, as part of a globally diversified portfolio.

Concluding Thoughts

This year has underscored the value of humility, flexibility, and depth of thinking. Whether it’s reevaluating economic durability, diversifying more meaningfully, or anticipating not just what policymakers do, but why they might reverse it, with this backdrop, we believe successful investing requires looking beyond immediate market reactions and economic impacts to consider subsequent, longer-term consequences.

Touchstone Asset Allocation Committee

The Touchstone Asset Allocation Committee (TAAC) consisting of Richard “Crit” Thomas, CFA, CAIA – Global Market Strategist, Erik M. Aarts, CIMA - Vice President and Senior Fixed Income Strategist, and Tim Paulin, CFA – Senior Vice President, Investment Research and Product Management, develops in-depth asset allocation guidance using established and evolving methodologies, inputs and analysis and communicates its methods, findings and guidance to stakeholders. TAAC uses different approaches in its development of Strategic Allocation and Tactical Allocation that are designed to add value for financial professionals and their clients. TAAC meets regularly to assess market conditions and conducts deep dive analyses on specific asset classes which is delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800-638-8194 for more information.

Word About Risk
Investing in Equities is subject to market volatility and loss. International and Emerging Markets equities also carry the associated risks of economic and political instability, market liquidity, currency volatility and differences in accounting standards. The risks associated with investing in international markets are magnified in Emerging Markets. Fixed Income/ Debt securities can lose their value as interest rates rise and are subject to credit risk which is the risk of deterioration in the financial condition of an issuer and/ or general economic conditions that can cause the issuer to not make timely payments of principal and interest also causing the securities to decline in value and an investor can lose principal.

The information provided reflects the research and opinion of Touchstone Investments as of the date indicated, and is subject to change without prior notice. Past performance is not indicative of future results. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing in certain sectors may involve additional risks and may not be appropriate for all investors.

Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on there sources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.

Touchstone Funds are distributed by Touchstone Securities, Inc.
A registered broker-dealer and member FINRA/SIPC.
A member of Western & Southern Financial Group