Touchstone Asset Allocation Guidance

This month, we look at potential headwinds in 2026. Given its importance to our economy and the market, we see AI as holding the biggest risk, but this risk can cut both ways. Most investors instinctively associate risk with falling prices rather than rising ones. Yet, rising prices tend to be the biggest risk for longer-term investors, as fears of losing money can lead to underinvestment at times.

By Touchstone Asset Allocation Committee

Allocation Update

Executive Summary

The outlook for 2026 is being shaped by crosscurrents that are likely to persist. The key question is whether their combined effect ultimately supports or pressures risk assets. For now, we lean modestly bullish but remain at our neutral strategic stock/bond weighting. We are alert to shifts that could change the balance.
Midterm election years have historically been volatile. Since the 1930s, the S&P 500 has experienced drawdowns of 15% or more roughly two-thirds of the time during midterm election years. In this environment, we favor quality, selectivity, and flexibility, but do not believe investors should reduce equity exposure. The S&P 500 remains in a secular bull market.
While we do not expect a repeat of 2025’s strong international equity performance, we believe returns can remain competitive with U.S. markets. Europe appears to be emerging from its economic malaise, with earnings poised to rebound. In addition, many emerging-market companies offer an alternative way to participate in the AI capacity build-out at much lower valuations.

Download Asset Allocation Guidance

Fixed Income

Weight: Neutral
We maintain a neutral stance as lower yields and tighter spreads modestly reduce expected returns, but bonds continue to play a critical strategic role as portfolio ballast and a source of stable income.

U.S. Taxable Investment Grade
Weight: Moderate Overweight
We are tactically overweight, drawn by higher yields and lower economic sensitivity, which offer appealing risk-adjusted return prospects relative to recent history.

Duration
Weight: Neutral
We remain neutral, as we believe interest rate risks have become more balanced. Slowing economic growth could pull yields lower, while sticky inflation and a pendulum swing towards fiscal dominance could push yields higher.

U.S. Taxable Non-Investment Grade
Weight: Moderate Underweight
We are underweight high-yield bonds, given tight credit spreads. However, loose financial conditions, higher index quality, and little sign of distress (in the public markets) reduce the need for a more defensive stance.

Equities

Weight: Neutral
We maintain a neutral allocation, reflecting a balance between risk and opportunity. Markets have responded positively to the Fed’s resumption of rate cuts, though policy uncertainty remains elevated.

U.S. Large Cap Blend
Weight: Neutral
The S&P 500 has risen roughly 80% over the past 3 years on a price basis, yet earnings growth accounts for less than half of those gains. The market could become more choppy, as stocks mark time while earnings catch up.

Growth
Weight: Moderate Underweight
We are underweight Growth due to elevated stock-specific risks among top constituents – including valuations that seemingly require continued earnings surprises and upward revisions to justify them. Performance has also diverged sharply across the Mag-7 over the past month.

Value
Weight: Neutral
We maintain our neutral weight to Value. Greater economic sensitivity and limited valuation support are balanced by sector-specific opportunities in oversold Healthcare, and in Financials supported by deregulation and a steeper yield curve.

U.S. Mid Cap
Weight: Slight Overweight
We hold a slight overweight, supported by more attractive valuations and potential earnings growth. Within mid caps, we prefer high quality companies with strong cash generation.

U.S. Small Cap
Weight: Neutral
We have a neutral weight. Third-quarter earnings were strong, with top-line upside the driver; however, softer labor conditions and uneven demand suggest patience is warranted.

International Developed
Weight: Neutral
We remain at our strategic weight, supported by reduced currency risk, attractive relative valuations, and lower prospective U.S. returns. However, Europe’s fragmented capital markets and regulatory burdens temper our enthusiasm.

International Emerging
Weight: Slight Overweight
We recently shifted to a slight overweight. Emerging markets are benefiting from Fed rate cuts and offer meaningful exposure to the less economically sensitive Technology sector, including key companies in the AI supply chain.

Strategic: Strategic asset allocation is a baseline allocation between asset classes established with a longer term focus and congruent with an investor’s investment goals and objectives. The allocation is meant to optimize the asset mix through methodical diversification in an attempt to maximize return and lessen risk.

Tactical: Tactical asset allocation is differentiated from strategic asset allocation by having a much shorter time horizon and the goal of adding alpha beyond what would be allowed through static strategic weights. Markets tend to be more volatile over shorter time horizons, while longer time frames tend to smooth out that volatility. That enhanced volatility in the short term creates the opportunity for either return enhancement and/or risk reduction by adding to or reducing weights of different asset classes.

About the Author

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.