Touchstone Asset Allocation Guidance

We believe we can add value by adjusting portfolio weights in response to changing market conditions and in anticipation of changing fundamentals. History demonstrates that risk assets move through repeated boom and bust cycles. While the economic cycle influences these cycles, they do not necessarily overlap with the risk asset cycle.

By Touchstone Asset Allocation Committee September 2, 2023

Economy & Markets

Executive Summary

The path of monetary policy remains the linchpin for the markets. We believe the Fed will hold current rates well into 2024.
The lagged effects of tight monetary policy are likely to lead to higher risk asset volatility, though lower inflation prints could provide an offset. It is something of a race to the bottom, and it is unclear which side will get there first, inflation or the economy.
Longer duration fixed income looks to be a good place to be while the above mentioned race ensues.

Download Touchstone Asset Allocation Guidance (PDF)

Fixed Income

Weight: Slight Overweight
Interest rates remain at levels not seen in more than a decade. Meanwhile, inflation has been coming down. The combination of these two factors are likely to translate into higher returns on an absolute and inflation adjusted basis.

U.S. Taxable Investment Grade
Weight: Modest Overweight
We currently favor higher credit quality exposure due to concerns over economic slowdown risks. We also find current interest rates to be very attractive, something we haven't been able to say for over a decade.

Duration
Weight: Modest Overweight
As economic growth decelerates we expect shorter term rates to fall. Shorter term rates falling faster then longer term rates typically occurs near the end of the Fed tightening cycle and accelerates when the Fed begins reducing rates.

U.S. Taxable Non-Investment Grade
Weight: Modest Underweight
The combination of recession risk and relatively narrow credit spreads keep us at a modest underweight, but are looking for an opportunity to add exposure should spreads widen.

Equities

Weight: Slight Underweight
Price declines in 2022 have created some buying opportunities, but a global economic downturn is not fully priced in. As valuations allow we will look to add more equity exposure.

U.S. Large Cap
Weight: Modest Underweight
Large cap valuations remain high on a historical basis as do profit margins, which remain near pre-pandemic highs, reducing earnings growth potential. The rally to date looks extended and our market breadth remains narrow.

Growth
Weight: Neutral
Growth stock outperformance year to date have been driven by a small group of stocks. Narrow leadership is typically not a healthy sign. While AI has created some excitement, for many of the leaders it has yet to translate into earnings growth.

Value
Weight: Neutral
More economically sensitive Value stocks are at risk of an economic downturn, though lower valuations should help provide some support. We currently remain neutral, but are looking for an opportunity to increase our exposure in anticipation of a Fed pivot.

U.S. Mid Cap
Weight: Modest Overweight
Mid-cap valuations are significantly below average on a historical basis versus their own history and relative to large caps. Mid-caps underperformed large caps despite stronger earnings growth over the past two years. Mid-caps have greater cyclical exposure than large caps, though less than small caps, and are likely to outperform when the economy recovers.

U.S. Small Cap
Weight: Modest Overweight
Regional banking concerns are easing and providing near-term asset class support. Small caps are experiencing a more significant revenue decline than large caps but could be poised for stronger growth next year, with easier comparisons.

International Developed
Weight: Modest Underweight
A less robust China re-opening is likely to weigh on trade-dependant Europe as well as tighter lending conditions. Additionally uncertainties remain with respect to the war in Ukraine. Valuations remain supportive.

International Emerging
Weight: Neutral
We removed our overweight given evidence of further economic weakness in China. Overall, emerging markets economic growth is still expected to outpace developed markets. Emerging market equities are trading at low valuations and lack lofty earnings expectations leaving
room for potential upside surprise.

*Reflects percentage point difference
Source: Touchstone Investments; assessments are made using data and information up to August 2023. For illustrative purposes only. Diversification does not guarantee investment returns and does not eliminate the risk of loss. Diversification among investment options and asset classes may help to reduce overall volatility.

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 Brian Cheyne, CFA, CIMA - Senior Investment Strategy Specialist, 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
Fixed-income securities can experience reduced liquidity during certain market events, 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. When interest rates rise, the price of debt securities generally falls. Longer term securities are generally more volatile. Investment grade debt securities may be downgraded by a Nationally Recognized Statistical Rating Organization to below investment grade status. Non-investment grade debt securities are considered speculative with respect to the issuers' ability to make timely payments of interest and principal, may lack liquidity and has had more frequent and larger price changes than other debt securities. Equities are subject to market volatility and loss. Growth stocks may be more volatile than investing in other stocks and may underperform when value investing is in favor. Value stocks may not appreciate in value as anticipated or may experience a decline in value. Stocks of large-cap companies may be unable to respond quickly to new competitive challenges. Stocks of small- and mid-cap companies may be subject to more erratic market movements than stocks of larger, more established companies. Investments in foreign, and emerging market securities carry the associated risks of economic and political instability, market liquidity, currency volatility and accounting standards that differ from those of U.S. markets and may offer less protection to investors. The risks associated with investing in foreign markets are magnified in emerging markets, due to their smaller and less developed economies.

Index Definitions
S&P 600^® Index is an unmanaged index considered representative of U.S. small-capitalization stocks.
S&P 500^® Index is a group of 500 widely held stocks and is commonly regarded to be representative of the large capitalization stock universe.
Bloomberg U.S. Aggregate Bond Index is an unmanaged index comprised of U.S. investment grade, fixed rate bond market securities, included in government agency, corporate and mortgage-backed securities between one and ten years.
Alpha is the portion of a fund’s total return that is unique to that fund and is independent of movements in the benchmark

In accordance with Rule 22c-2 under the 1940 Act, Touchstone Funds has no arrangements to permit any investor to trade frequently in shares of the Funds, nor will they enter into any such arrangement in the future.
Fed is abbreviated for the U.S. Federal Reserve Board.
AI is abbreviated for artificial intelligence.

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.

The indexes mentioned are unmanaged statistical composites of stock or bond market performance. Investing in an index is not possible.

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Investment return and principal value of an investment in a Fund will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. All investing involves risk.
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