Prefer longer-duration bonds

Each month, the SSGA Investment Solutions Group (ISG) meets to debate and ultimately determine a Tactical Asset Allocation (TAA) to guide near-term investment decisions for client portfolios. Here we report on the team’s most recent discussion.

Macro backdrop

In the absence of fresh government data due to the shutdown, current indicators align broadly with existing trends. The economy remains two-sided: lower-income households face rising delinquencies, especially in subprime credit, while higher-income consumers—supported by strong financial assets—continue to drive spending. Growth signals are mixed. On the positive side, the Atlanta Fed’s Q3 GDP estimate rose to 4%, and services PMI improved on stronger new orders. Conversely, preliminary October sentiment from the University of Michigan weakened, reflecting persistent market anxiety. Overall, while pockets of stress exist, resilience in key areas keeps us constructive on 2026 growth.

The Fed cut rates as expected at its October meeting, but comments from Jerome Powell indicated that a rate cut in December is not a foregone conclusion. He noted that current private data sources do not indicate a significant change in labor and employment trends; however, in the absence of reliable data, the Federal Reserve may delay easing. This was met with a significant repricing of the December cut probability—from the 90s to 70%—and fixed income sold off sharply in response.

Despite recent comments from the Federal Reserve, we expect them to deliver an additional 25 bps cut this year, bringing the total to 75 bps, followed by another 50 bps of easing in 2026. While Fed officials remain divided, with two dissents in their recent meeting, signs of labor market softness should keep them on track to reduce rates. Inflation risks persist—particularly from tariff pass-through—but these pressures are expected to be one-time contributors, and continued declines in rents, weaker labor conditions, and slower migration should help offset them.

Prices paid in the ISM manufacturing index continue to fall, and plans to raise prices in the NFIB small business survey declined in October. Elsewhere, oil prices have generally moved lower, and labor market weakness should help keep wage pressures in check. Overall, inflation remains above the Fed’s target, but there are enough signs it should be manageable, allowing the Fed to focus on combating labor market weakness and delivering further rate cuts.

Directional trades and risk positioning

Our recent model updates reflect a generally positive backdrop for risk assets, though with nuanced shifts. While our methods for assessing attractiveness have diverged slightly, they still point to supportive conditions. Risk appetite estimates have softened, even as equity forecasts strengthened, but both indicators remain constructive overall. Bond forecasts declined but remain positive. In response to the modest dip in risk appetite, we trimmed equity exposure slightly yet continue to maintain a healthy overweight position. The proceeds were deployed back into aggregate bonds, though we maintain a healthy underweight.

After a period of relative stability, our Market Regime Indicator (MRI) saw renewed volatility in October as macro and geopolitical developments unsettled investors. The month began with a US government shutdown and disappointing economic data, including weak service activity and a soft ADP employment report. Sentiment deteriorated further when the US threatened additional tariffs in response to China’s rare earth export restrictions. While oil prices spiked on new US sanctions against major Russian producers, optimism returned on constructive US–China trade signals. Late in the month, the Fed cut rates and ended quantitative tightening, but its hawkish tone tempered enthusiasm. From a model perspective, changes were driven by implied equity volatility, which surged to levels near those seen on “liberation day,” and risky debt spreads that widened before partially recovering. Despite these shifts, both measures still point to positive—though moderating—risk appetite. Meanwhile, sentiment spreads and equity trends remain supportive. Overall, the MRI’s risk-on signal has softened but continues to favor equities, albeit with slightly less conviction than in prior months.

Despite renewed uncertainty in October, our outlook for equities has strengthened modestly, improving month over month. Across the broad set of indicators we monitor, equities appear attractive, with improvement evident across multiple factors. The most significant driver of this more optimistic view is a notable improvement in sentiment—sales and earnings estimates have risen sharply, signaling confidence in corporate fundamentals. In addition, better price momentum and stronger quality factors are providing further support, helping to offset valuations that remain somewhat less compelling. Taken together, these dynamics suggest a favorable environment for equities, and we believe maintaining a healthy overweight position continues to be well warranted.

While our expectations for fixed income assets have moderated, they remain positive overall. Our model anticipates no major change in yields, but carry remains favorable. Current yields, when viewed against longer-term trends, suggest a tendency toward mean reversion, which would typically point to lower yields ahead. However, this is counterbalanced by stronger momentum in commodities, signaling higher growth and inflation expectations that could keep rates elevated. Within credit markets, our models foresee stability in investment-grade spreads and a small widening in high-yield spreads, reflecting mixed signals across risk factors.

On one hand, lower yields imply easier financial conditions and a supportive backdrop for spreads; on the other, softer equity momentum and higher implied volatility suggest some pressure on credit risk premiums. Taken together, these offsetting forces lead us to maintain a constructive outlook for fixed income, with positive return expectations and a preference for longer-dated bonds where we see the most opportunity for returns.

Relative value trades and positioning

Our regional equity outlook has strengthened broadly, with improvements across most regions and only a slight decline in US small-cap forecasts—which remain positive overall. The US continues to rank as our top region, supported by strong signals across nearly all factors except valuations. Within the US, however, weaker quality metrics and softer macroeconomic indicators have tempered our view on small caps. Outside the US, emerging markets maintain a positive outlook, buoyed by improved price momentum and stronger sentiment indicators.

For non-US developed markets, our stance has become more constructive, driven by a notably better Pacific forecast and a less negative outlook for Europe. In Europe, modest improvement reflects less pessimistic analyst expectations for sales and earnings, though weak price momentum still weighs on the region despite attractive valuations. Conversely, Pacific equities benefit from improved price momentum, positive sentiment, and supportive macro conditions, reinforcing our upgraded view. In response to these shifts, we made a small rebalance—reducing our US small-cap overweight and reallocating to Pacific equities, which now hold an overweight position at the total portfolio level. Overall, we maintain a preference for US and emerging market equities, with a slight underweight to non-US developed markets.

Within fixed income, we made targeted adjustments to align the portfolio with our model’s preference for higher-quality and longer-duration exposure. Specifically, we sold aggregate bonds to offset prior directional trades and reduced our allocation to high-yield bonds, bringing that position back to neutral. The proceeds were redeployed into long-dated government bonds and long investment-grade credit, reflecting our view that extending duration and improving credit quality will position the portfolio to capture attractive return potential. These changes underscore our commitment to balancing risk and opportunity in a shifting rate environment.

Within our US equity sector rotation strategy, communication services and health care remain at the top of our rankings, supported by strong underlying fundamentals. Communication services continues to exhibit exceptional strength in price momentum and sentiment—where it ranks highest—alongside improving quality factors and valuations that remain attractive. Health care presents a more mixed picture but still holds enough positive signals to stay near the top, with sentiment remaining constructive and valuations appealing, even as price momentum has softened. In contrast, consumer staples fell sharply in our rankings due to weakening across multiple factors; while valuations remain favorable, deteriorating price momentum and negative macro indicators prompted us to rotate out of the sector. Technology climbed our rankings, benefiting from robust price momentum and strong sentiment around both earnings and sales. Although valuations in tech appear stretched, positive quality factors—such as operational efficiency and strong balance sheets—support its relative attractiveness.

To see sample Tactical Asset Allocations (TAA) and learn more about how TAA is used in portfolio construction, please contact your State Street relationship manager.