Steady equities, stronger credit

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

Momentum from 2025 has carried forward, but with policy headlines and geopolitical tensions still shaping the narrative. Even so, the US economy continues to show resilience. Our outlook remains the same: growth should strengthen in 2026 as inflation moves lower. The lagged effects of Fed rate cuts, fiscal stimulus, ongoing AI investment, and improving business sentiment are set to support stronger job growth and reinforce consumption. At the same time, fading tariff impacts and continued declines in rental pressures should keep inflation on a downward path. While firmer growth could prompt the Fed to pause, we believe still‑restrictive policy, easing inflation, and the Fed’s aim to move toward a roughly 3% neutral rate will ultimately lead to another 75 basis points of rate cuts in 2026.

As we look ahead to 2026, the US economy presents a nuanced picture—balancing ongoing challenges with several reasons for optimism. The labor market, while expected to stabilize, still shows signs of softness. Recent payroll gains have been modest, and wage growth has slowed. Although layoffs remain muted and jobless claims are low, overall job creation is only mediocre. Elevated delinquency rates and cautious consumer sentiment suggest that not all households are feeling confident. A persistently weak labor market or a drop in asset prices could further restrain income and spending growth.

Despite these headwinds, several forces are positioned to support the economy in 2026. The newly enacted One Big Beautiful Bill Act (OBBBA) delivers meaningful tax relief through extended cuts, higher deductions, and targeted incentives for households and businesses. These measures are expected to lift household incomes and consumption, adding an estimated 0.2 percentage points to spending growth and providing a notable boost to GDP.

Improved financial conditions and new tax incentives should encourage business investment, particularly in manufacturing and AI‑driven capital expenditures. Corporate profits are also broadening beyond tech, with profit growth expected to remain above trend.

While job growth has been subdued, leading indicators, such as small‑business hiring plans and improving optimism, point to a potential rebound. We expect job growth to stabilize and possibly strengthen as tariff-related drags fade and fiscal stimulus flows through.

Inflation is projected to ease further in 2026, outpacing wage growth and lifting real incomes, giving households a firmer foundation for consumption. Meanwhile, looser bank lending standards and recent gains in equity markets should continue to support spending through positive wealth effects.

We remain constructive on the US outlook, but several risks warrant close attention. The most important one centers on the consumer: a rise in unemployment could weaken spending. A decline in equity markets could also erode the wealth effect that has supported households. And elevated geopolitical tensions could weigh on sentiment and push prices higher, creating a headwind for growth. These developments are not part of our base case, but they represent risks that could challenge our outlook.

Directional trades and risk positioning

While our forecasts have evolved, the broader outlook remains intact: risk appetite is solid, equity signals are firm, and we continue to expect equities to outperform fixed income. Within real assets, gold and broad commodities remain appealing. As a result, we made only minor tactical adjustments this month, keeping our positioning aligned with these core preferences.

Our quantitative read on risk appetite remains constructive. Despite ongoing geopolitical uncertainties and the ripple effects of a hawkish Bank of Japan, sentiment has held steady—and even improved—according to our Market Regime Indicator (MRI), which continues to signal a favorable backdrop for equities. Key drivers include softer‑than‑expected US inflation, resilient labor market data, and another Fed rate cut paired with a less hawkish tone from Chair Jerome Powell. Together, these developments have supported market confidence.

On the factor side, implied volatility has moved into euphoric territory, reflecting a sharp decline from previously elevated equity volatility. While sentiment spreads have softened slightly, the signal has trended higher over the past two months. Both factors remain supportive, and combined with positive equity trend signals, reinforce our conviction that an overweight in equities is warranted.

Our forecasts have shifted modestly. The equity outlook softened somewhat due to weaker macro drivers—primarily reduced cross‑sector volatility—though momentum, sentiment, and quality factors keep the view constructive.

In fixed income, we now expect a smaller decline in yields and hold a more optimistic stance on credit. Softer commodity momentum and mean reversion still signal lower yields, but strong equity momentum limits the extent of that decline. Credit spreads are expected to tighten, supported by lower rates, improved risk appetite, and reduced equity volatility.

Our portfolios remain tilted toward risk assets, anchored by a substantial equity overweight, which we increased by trimming aggregate bonds. We also maintain a modest overweight to gold and broad commodities.

Relative value trades and positioning

From a regional equity perspective, our rankings remain unchanged, though the outlook for non‑US developed markets has weakened meaningfully. The US and emerging markets continue to be our preferred regions, supported by strong sales and earnings expectations as well as solid quality metrics.

Europe has become less attractive given deteriorating momentum and poor sentiment, while the Pacific region faces weaker quality metrics and fading momentum. As a result, we made no changes during the January rebalance and continue to hold a large overweight to the US and a modest overweight to emerging markets.

We trimmed our overweight in long Treasuries and rotated into long credit bonds. With the outlook for spreads improving, this shift allows us to enhance returns without materially altering our duration profile.

Within our US equity sector rotation strategy, communication services, technology, and health care remain at the top of the rankings. Technology and communication services continue to score well across most factors, driven by strong price momentum, robust sentiment, and solid quality metrics.

Consumer staples, by contrast, fell in the rankings due to broad‑based weakness—especially in momentum and sentiment. Health care has moved up to replace it, supported by improving price momentum and favorable sales and earnings expectations.

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.