Trim equities, add duration

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

Recent data underscore ongoing fragility in the labor market, which remains a key downside risk to economic growth. Job openings have fallen to their lowest level since September 2022—layoffs reported by Challenger, Gray & Christmas, an outplacement firm, surged in January, and private payroll growth disappointed, collectively signaling softer labor demand. That said, conditions are not deteriorating toward a worst case scenario.

The Job Openings and Labor Turnover Survey (JOLTS), which captures job openings as well as hiring and separation activity, is prone to sizable revisions and has recently diverged from more stable indicators such as Indeed job postings. Moreover, overall labor market turnover remains relatively unchanged, with hiring and separation rates broadly steady.

Importantly, this labor market softness contrasts with more constructive signals from the broader economy. Third quarter US GDP exceeded expectations, supported by resilient consumer spending and a narrowing trade deficit. Looking ahead, fourth quarter GDP is tracking at a robust 4.2% according to the Atlanta Fed’s GDP estimate. Manufacturing activity has improved meaningfully, with the ISM manufacturing index reaching its highest level since 2022 and new orders accelerating.

While some of this strength may reflect post holiday inventory normalization, the underlying trend remains encouraging. Services activity continues to expand steadily. Corporate fundamentals are also supportive, as strong S&P 500 earnings for Q4 would mark the fifth consecutive quarter of double digit earnings growth.

Looking forward, improving business confidence and solid profitability should help stabilize labor market conditions. Corporate investment is likely to remain a key pillar of growth, with AI related capital expenditures continuing to provide support. In addition, accelerated depreciation provisions could incentivize investment beyond hyperscalers. The wealth effect remains intact, financial conditions have eased, and fiscal support from the One Big Beautiful Bill Act should further underpin economic activity.

Despite Fed chair nominee Kevin Warsh’s preference for lower policy rates and balance sheet reduction, he will remain only one voice on the FOMC, the Fed’s monetary policy setting committee, limiting the likelihood of a material shift in the policy framework.

However, monetary policy should become more supportive over time. While not a high conviction call, we anticipate an additional 75 basis points of Fed rate cuts in 2026. With inflation pressures remaining manageable, labor market momentum softening, and the Fed seeking to move closer to a neutral policy stance around 3%, further rate cuts in 2026 appear warranted.

Overall, the macro backdrop remains consistent with continued economic resilience. While risks remain and warrant close monitoring, the balance of evidence supports a constructive outlook for growth.

Directional trades and risk positioning

Our assessment of current market conditions points to a less supportive backdrop for risk assets. While investor risk appetite remains positive, it has moderated, alongside softer expectations for equities and credit, and an improved outlook for government bonds. Within real assets, commodities and gold continue to offer attractive opportunities. In response, we have reduced portfolio risk by trimming equity exposure, increasing allocations to bonds, and rotating into commodities.

From a quantitative perspective, our Market Regime Indicator (MRI) has weakened, signaling a higher degree of risk aversion. A confluence of geopolitical developments, including Iran related risks, concerns around Federal Reserve independence, and events in Venezuela, alongside central bank actions and renewed AI related concerns has tempered investor optimism.

Within our framework, this shift is reflected in widening sentiment spreads and rising equity and currency implied volatility, both of which have become less supportive over the past two months. Although equity price trends remain positive, weak credit market sentiment and diminished risk support offset these signals. Overall, the MRI continues to point to a modestly positive environment for risk assets, but one that warrants a reduction in the size of our overweight positioning.

Equities have navigated a range of headwinds successfully; however, our forward looking outlook suggests less robust returns. While price momentum remains constructive, expectations for both sales and earnings have softened modestly. Support from the quality factor has also eased, though it remains positive. Taken together, these dynamics imply more moderate expected equity returns going forward.

Our fixed income model indicates a constructive outlook for rates, with government bond yields expected to decline alongside a modest widening in credit spreads. A softer risk appetite backdrop, easing equity momentum, and signals of mean reversion all support lower sovereign yields. In credit markets, while lower yields remain a supportive factor, fading equity momentum, elevated implied equity volatility, and a deterioration in overall risk appetite suggest that spreads are likely to widen.

Our commodity outlook has moderated in line with other risk assets but remains firmly positive. The primary driver of the downgrade has been our skewness, or contrarian signal: strong recent performance—particularly across precious and industrial metals—suggests investor pessimism has eased, reducing the scope for a near term rebound. Elsewhere, curve structure and trend indicators continue to point to positive forward returns, supporting a constructive view on commodities.

Overall, we continue to hold a meaningful overweight to equities, complemented by modest overweight allocations to commodities and gold.

Relative value trades and positioning

Within equities, forecasts across regions have moderated, though our relative rankings remain unchanged. The US continues to be our most favored region, supported by robust sentiment indicators and strong quality characteristics, including healthy balance sheets and a high capacity to generate returns on assets. Within the US, our small cap outlook has strengthened relative to large caps, driven by stronger price momentum, improving sentiment, and more supportive macroeconomic indicators.

Our outlook for emerging markets also remains constructive, underpinned by firm price momentum and solid sales and earnings expectations. In contrast, expectations for non US developed equities remain weak, as these markets are comparatively less attractive across sentiment, quality, and macroeconomic dimensions. In February, we implemented a modest allocation adjustment by reducing exposure to Pacific equities, now underweight, and reallocating the proceeds to US small cap equities, extending our overweight position.

Given expectations for a healthy decline in yields, we executed a targeted adjustment within fixed income to capture more attractive opportunities. While in the directional trade we added to aggregate bonds, in the relative trade, we reduced exposure, resulting in a small net buy. We increased allocations to long duration government bonds, extending our overweight positioning.

Within our US equity sector rotation framework, communication services, financials, and health care currently rank highest. Technology has fallen out of favor, reflecting broad based deterioration across key factors, including price momentum, quality, and sentiment.

Communication services remain our preferred sector, supported by strong readings across nearly all factors, with the exception of macroeconomic sensitivity. Our improved outlook for financials reflects a notable strengthening in sentiment, complemented by reasonable valuations and supportive macroeconomic indicators. Health care also screens favorably, with broad based support across multiple factors, particularly sentiment and momentum, underpinning a constructive outlook.

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.