Touchstone Asset Allocation Guidance

We shifted a slight overweight from mid caps to large cap growth as stronger forward earnings, better revision momentum and a meaningful valuation reset improved its relative risk/reward. At the same time, Treasury yields have moved higher largely because the economy has surprised to the upside—a healthier backdrop for risk assets than a rate increase driven primarily by renewed inflation fears.

By Touchstone Asset Allocation Committee

Allocation Update

Executive Summary

We moved our slight overweight in mid caps to large cap growth. The combination of stronger forward earnings growth, better revision momentum and meaningful multiple contraction has improved the relative risk-reward profile of large cap growth. Stocks had a strong August despite continued geopolitical uncertainty. Both U.S. and international markets rebounded from a weak July, helped by another healthy earnings season. Importantly, earnings strength has extended beyond the largest U.S. technology companies. The market continues to mirror the resilience of the economy.
Following a timely downgrade in duration in August, yields have surged on sharply better than expected economic data and a hawkish Fed hike. We believe these higher rates may prove sticky. Our economy has proved to be less interest rate sensitive. Sticky higher rates are also consistent with our regime change hypothesis, reflecting a shift in the supply and demand for debt as growing supply requires higher yields to attract capital.
We remain moderately overweight equities, supported by healthy earnings and resilient economic growth. But inflation, geopolitical risks and uncertainty around the Fed argue against becoming more aggressive. Within fixed income, we prefer higher-quality credit and remain underweight high yield. We remain constructive but believe this is a time for measured risk-taking.

Download Asset Allocation Guidance

Fixed Income

Weight: Moderate Underweight
We maintain moderate tactical underweight as we continue to see more attractive return opportunities in equities. Bond yields have become even more appealing, offsetting inflation risks, fiscal concerns, and a less communicative Fed.

Duration
Weight: Neutral
We shifted duration back to neutral as the risks have become more balanced. Heavy borrowing needs from the federal government and AI-related infrastructure investment are increasing competition for capital putting upward pressure on long-term yields.

U.S. Taxable Investment Grade
Weight: Neutral
We remain neutral. Yields are attractive, but significant data center-related issuance, particularly on the long end of the curve, creates additional competition for capital and argues for selectivity in issuer, maturity and structure.

U.S. Taxable Non-Investment Grade
Weight: Moderate Underweight
We remain underweight high-yield bonds. Credit spreads provide little cushion should inflation remain elevated or economic growth begins to slow.

Equities

Weight: Moderate Overweight
We maintain a moderate overweight, supported by resilient economic data and continued earnings strength. While AI remains the dominant market driver, there are some encouraging signs that earnings growth is broadening beyond AI-related companies.

U.S. Large Cap Blend
Weight: Moderate Overweight
We maintain a moderate overweight. Strong earnings growth and continued AI-related investment have supported equity markets. Constraints on data center buildout such as permitting and power needs could create some earnings risk, though AI demand remains very strong.

Growth
Weight: Slight Overweight
We tactically shifted Growth to a slight overweight. Strong earnings growth and continued AI-related investment remain supportive. Continued strength in AI demand and greater visibility into 2027 has increased our confidence, though the change was incremental as the risk profile is high.

Value
Weight: Neutral
We remain neutral. The Value index contains a diverse mix of defensive, cyclical, and even growth-oriented companies that have migrated from Growth benchmarks. While we see attractive opportunities within the universe, we believe they are best captured through active management.

U.S. Mid Cap
Weight: Neutral
We removed our slight overweight, shifting to neutral. Earnings revisions and breadth have improved, although mid caps have recently lagged large caps due to a slower rate of EPS growth. We decided to follow the relative earnings strength by adding to large cap growth.

U.S. Small Cap
Weight: Neutral
We remain neutral. Earnings and sales revision breadth have improved, although relative performance has yet to provide decisive confirmation and higher interest rates create a new headwind.

International Developed
Weight: Neutral
We remain neutral, though the outlook has improved modestly. Earnings have been materially better and European economic growth is modestly exceeding expectations. However, sustained higher energy prices and rates suggest a dose of caution is warranted.

International Emerging
Weight: Slight Underweight
We remain slightly underweight. EM returns have become increasingly dependent on three large, historically cyclical semiconductor companies. This concentration makes the asset class more dependent on company-specific fundamentals and less on the broader macro factors that typically guide our allocation decisions.

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.