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

Economy & Markets

Executive Summary

While Fed Chair Powell’s Jackson Hole speech brought some joy to the markets, the outlook remains unsettled with both upside and downside risks. Given this uncertainty, we remain fairly close to our strategic weights.
With tariff uncertainty easing in August, recent data show an uptick in economic activity. Still, as Powell stated in his Jackson Hole speech, “in this environment, distinguishing cyclical developments from trend, or structural, developments is difficult.”
We expect the Fed to cut rates by 25 basis points in September, though upcoming employment and inflation reports could shift the prospects of a cut. The cutting cycle is likely to be gradual, and we expect longer maturity yields may remain range-bound, barring a major change in economic growth or inflation.

Download Asset Allocation Guidance

Fixed Income

Weight: Slight Overweight
We maintain a slight overweight. With some widening economic cracks and policy uncertainty, fixed income offers attractive income and competitive risk- adjusted return potential relative to equities.

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.

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 that credit spreads continue to narrow in the face of expected slowing in economic growth. However, loose credit conditions, higher index quality, and a manageable maturity wall reduce the need for a highly defensive stance.

Equities

Weight: Slight Underweight
We are slightly underweight equities overall, due to reduced exposure to both U.S. large-cap Growth and small-cap, partly offset by a moderate overweight to mid-caps.

U.S. Large Cap Blend
Weight: Neutral
We see some near-term risk of market correction this fall. However, without a recession (not our assumption), we believe a correction could create a buying opportunity.

Growth
Weight: Moderate Underweight
We remain 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.

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 Financials, supported by deregulation and a steeper yield curve.

U.S. Mid Cap
Weight: Moderate Overweight
We maintain a mid cap overweight, favoring the segment for its attractive valuations, lower international exposure, and less economic risk compared to small caps. Within mid caps, we prefer high-quality companies with strong cash generation.

U.S. Small Cap
Weight: Slight Underweight
We are slightly underweight small caps, reflecting greater earnings risk. Small business owner sentiment has recently improved, though capital spending plans remain depressed.

International Developed
Weight: Neutral
We moved to a strategic weight, supported by reduced currency risk, attractive relative valuations, and lower U.S. return prospects. However, Europe’s fragile recovery, fragmented capital markets, and regulatory burdens temper our enthusiasm.

International Emerging
Weight: Neutral
Our strategic weight is based on similar factors as Developed markets: reduced dollar risk, attractive valuations, and more tepid U.S. return expectations. EM is hard to generalize as prospects differ by country and company.

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.