- Following the U.S. elections, we increased our large cap allocation, offsetting this with a reduction in emerging markets. This adjustment reflects our belief that the new administration’s policies will be more constructive for domestic companies relative to overseas companies.
- Last month we questioned 2025 earnings growth estimates of 14%. Since then, expectations have been reduced to 12%. While earnings were revised down modestly, S&P 500 gained approximately 5%. The S&P 500’s forward P/E ratio has only been higher than current levels twice in the past 25 years: during the late-stage dot-com bubble and in 2020/2021 when stock prices surged as earnings declined due to a pullback in consumer spending. Starting valuations are crucial to investment returns; the higher the initial valuation, the greater the likelihood that long-term returns will fall below average, although valuations could continue to rise in the near term.
- Projected profit margin growth of nearly 1 percentage point seems optimistic. Margin growth aligns with revenue growth expectations, but 2025 economic growth is forecast to slow compared to 2024, which could constrain revenue. Operating margins are projected to reach their highest level in over a decade. Tariffs remain a risk, as they contributed to margin declines when implemented in 2018.
- That said, we are not negative on earnings, the economy is expected to grow, the secular AI trend remains strong, businesses may benefit from reduced regulations, and corporate tax cuts appear likely. And with easier monetary conditions we remain relatively constructive, despite high valuations.
- Despite the likely sweep of the executive and legislative branches, the practicalities of governance may limit the incoming administration’s willingness to implement all of the campaign promises and/or enact them to their full extent.
We are maintaining a moderate underweight in Growth while holding a slight overweight in Value. The allocation between Value and Growth stocks remains challenging, as mega cap technology stocks, with their potential earnings growth and high valuations, create a stark contrast with the broader U.S. equity market, especially Value stocks.
- Large cap growth stocks have been primarily driven by high expectations around the secular AI trend as core AI infrastructure is developed. Historically, it often takes many years for new technology adoption to significantly impact sales and earnings. Additionally, the exceptional earnings growth seen in AI focused companies will be difficult to sustain.
- Value companies typically possess more tangible assets (e.g., factories), while Growth companies are generally asset light (e.g., cloud-based). Despite these differences, stock returns are heavily influenced by their valuations. In theory, stocks with different fundamentals should be priced such that investors are indifferent between them, as their future prospects are balanced through valuation adjustments.
- Utilities have performed well in 2024, driven by increased AI related energy demand and investor interest in yield as rates have declined. As one of the most heavily taxed sectors, Utilities could benefit from potential tax reductions. Industrials, also highly taxed, may benefit from stronger domestic growth.
- Financials could be a dark horse in the Value segment this year due to stronger net interest margins, especially if the Fed continues to lower short-term rates while longer-term yields remain elevated due to market forces.
- We maintain overweight positions in mid caps and small caps, as both earnings growth potential and valuations support moving down cap.
- The results of the U.S. election may provide additional tailwinds for small and mid caps compared to large caps. Regulations are expected to ease which could reduce costs for companies and increase profits. Reduced antitrust concerns could spark M&A activity. Small and mid cap lower valuations could make them attractive targets for larger companies to boost growth.
- Corporate tax cuts could be forthcoming. Companies have been paying higher taxes in recent years as some provisions from the 2017 tax cuts expired, and President-elect Trump has promised further reductions to the base tax rate. Small and mid caps generally source more of their profits domestically, as such they are likely to benefit more from a lower domestic tax rate than larger companies with significant international exposure.
- Looking ahead to 2025, small caps are projected to have strong earnings growth – up 17% – as they rebound from a low base following two years of declines. Forecasted earnings are still slightly below 2022 levels, while current valuations are only slightly higher. Mid cap earnings are expected to rise by 14% in 2025. Although mid cap valuations aren’t as attractive as they were at the beginning of the year, they remain favorable relative to their own history and to large caps.
- While we remain optimistic, we recognize that risks have increased. We have viewed the recent rate cuts, beginning in September and confirmed in the most recent Fed meeting, as favorable for small caps. However, stimulative fiscal policies and stronger economic growth could keep inflation elevated, which could challenge the assumption of lower rates going forward.
Equity Indexes Characteristics
The Indexes mentioned are unmanaged statistical composites of stock market or bond market performance. Investing in an index is not possible.
The Touchstone Asset Allocation Committee
The Touchstone Asset Allocation Committee (TAAC) consisting of 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 are delivered via the Asset Allocation Summary document. Please contact your Touchstone representative or call 800-638-8194 for more information.
A Word About Risk
Investing in fixed-income securities which 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 which may be downgraded by a Nationally Recognized Statistical Rating Organization (NRSRO) to below investment grade status. U.S. government agency securities which are neither issued nor guaranteed by the U.S. Treasury and are not guaranteed against price movements due to changing interest rates. Mortgage-backed securities and asset-backed securities are subject to the risks of prepayment, defaults, changing interest rates and at times, the financial condition of the issuer. Foreign 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. Emerging markets securities which are more likely to experience turmoil or rapid changes in market or economic conditions than developed countries.
Performance data quoted represents past performance, which is no guarantee of future results. The investment return and principal value of an investment in the Fund will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than performance data given. For performance information current to the most recent month-end, visit TouchstoneInvestments.com/mutual-funds.
Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.
Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.
Touchstone is a member of Western & Southern Financial Group
Not FDIC Insured | No Bank Guarantee | May Lose Value
