The first half of this year has underscored crucial lessons for investors including the importance of diversification and balancing risk, particularly in volatile markets. Coming into the year, economic data suggested a continuation of a strong macroeconomic environment, characterized by robust corporate earnings, buoyant labor markets and above-trend GDP growth. Yet, the announcement of U.S. tariffs initiated concerns about lower economic growth and higher inflation. This combination led equity volatility to peak at its third-highest level in the past 50 years.¹ In April alone, the S&P 500 experienced its worst single-day performance since March 2020, and also having its best day since October 2008. In fixed income markets, the yield on 10-year U.S. Treasuries fluctuated between 3.9% to 4.6% in April, followed by increased volatility in May amid growing concerns over U.S. fiscal policy. Against this backdrop, our portfolios balanced and diversified exposures. As we enter the second half of the year, we remain mindful of the tariffs’ effect on inflation and growth, and subsequently on the future of Federal Reserve interest rate cuts. Greater clarity on the administration’s proposed tax bill and deregulation agenda will also be important considerations. Given the macroeconomic landscape, let’s recap how our model portfolios are positioned and our outlook.

Portfolio Positioning

Equity: Tactical models are marginally overweight headline equity, while Strategic models are neutral headline equity relative to benchmark. 

• Tactical models: Portfolios started the year with a pro-risk stance, expressed by an overweight to equity, specifically U.S. equity in a 60/40 portfolio. With the changing policy landscape, portfolios began reducing equity risk exposure in early February. Portfolios risk-managed positions throughout March and April, ultimately aligning exposure across regions, market caps and styles closer to benchmark. On a total return basis, international market positions were additive as these markets saw strong performance; a weaker U.S. dollar and earnings revisions benefited regions such as the eurozone and Japan. Most recently, portfolios increased exposure to headline equities as recession probabilities have come down as of late June.
• Strategic models: Portfolios started the year neutral headline equity with a preference for U.S. large cap given earnings strength driven by a resilient U.S. consumer. Additionally, our portfolios came into the year with an overweight to both small and mid-cap equity and emerging markets equity. However, the small and mid cap equity positions were reduced due to extended valuations and a lower growth environment. The emerging markets equity allocation was modestly decreased as our 2025 Long- Term Capital Market Assumptions expect slower growth versus history.
• Outlook: While we believe tariff and market volatility peaked in April, prolonged uncertainty poses challenges to equity valuations and economic growth. Yet, U.S. corporates continue to deliver resilient earnings growth as shown in the chart below. With U.S. equity valuations touching near-term highs, we await further clarity on U.S. policies’ impact on inflation and the labor market. We continue to monitor opportunities in the U.S., focusing on durable corporate margins and recent positive capital expenditure guidance, especially in large cap equity. On the international front, we see long-term opportunity in international developed equity as Germany’s fiscal reform may boost infrastructure and defense spending, thus enhancing economic growth and potential for attractive entry points. Following years of fiscal austerity, this stimulus in the Eurozone’s largest economy stands out as we consider medium-to long-term opportunities in the region.²

Fixed Income: Maintain conviction and an overweight to extended credit versus the benchmark.

• Tactical models: Coming into the year, 60/40 portfolios were overweight credit by over 10%. As tariff announcements led to higher volatility and increased recessionary risks, we balanced risk in portfolios by adding to core bonds, consequently decreasing our credit overweight to ~5%. Today, we maintain our conviction in credit as revenues are strong, default rates are low and leverage and interest coverage ratios remain below long-term historical trends. We continue to prefer securitized credit, as it offers exposure to high-quality consumer assets with greater stability against market fluctuations.
• Strategic models: As credit spreads widened and all-in yields became more attractive at the end of the first quarter, the portfolios introduced a flexible income strategy and a direct high yield allocation. Today, the 60/40 portfolio is 2% overweight extended credit. Improved credit ratings and lower default rates have provided a compelling opportunity to add risk within fixed income.
• Outlook: While the credit market experienced some volatility this year, it still has fundamental support as corporate and consumer balance sheets remain healthy. The demand for extended credit is robust as all-in yields remain attractive. As bond market volatility continues, we believe that anchoring core bonds with extended credit is prudent to diversify fixed income risk and exposures. At a total portfolio level, we prefer to take incremental risk in credit over equity due to its attractive risk-adjusted return, delivering a healthy all-in yield (~7-8% per annum) with a third of the volatility of equity.³