Touchstone Asset Allocation Guidance

Markets are navigating an unusual mix of geopolitical risk, rising yields, and shifting AI leadership. While higher oil prices have lifted inflation concerns, we believe growth risks may ultimately prove more important. Against this backdrop, we are leaning slightly longer in duration, staying selective in U.S. equities, and maintaining balanced global exposure.

By Touchstone Asset Allocation Committee

Allocation Update

Executive Summary

We believe the rise in yields in response to the war in Iran is an unusual reaction, as bonds typically rally on safe-haven demand. The rise in yields suggests inflationary risk. While a sustained rise in oil prices can create headline inflation risk, we are skeptical that higher oil prices allow firms outside the energy sector to pass through price increases.
U.S. equity leadership is shifting as investors reassess the impact of AI across industries. Investors are increasingly taking AI’s potential more seriously and have begun to distinguish between companies positioned to improve margins and productivity through AI and those facing potential disruption. This has increased return dispersion which should create a more favorable environment for active management.
International stocks are likely to see near term underperformance due to the war in Iran given expected dollar strength and higher oil prices. These headwinds are likely to unwind quickly once a resolution is found. An extended closure of the Strait of Hormuz is a risk, though difficult to handicap.

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.

Duration
Weight: Slight Overweight
We shifted to a slightly overweight duration stance. For a fully diversified fixed income portfolio, we characterize this change as moving closer to the overall duration of the Bloomberg U.S. Aggregate Bond Index.

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.

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 75% over the past 3 years on a price basis, with earnings contributing less than half of those gains. The market has become choppier, as stocks mark time while earnings catch up.

Growth
Weight: Moderate Underweight
We remain underweight Growth due to elevated stock-specific risks among top constituents, including valuations that seemingly require sustained earnings acceleration. New AI product introductions have created significant return dispersion within Growth. We believe selectivity is critical.

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 maintain 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.