Confluence Asset Allocation Quarterly

• The firm excludes US small caps due to expected headwinds from tariff-related cost pressures, higher financing costs, and limited pricing power, while maintaining large-cap exposure with sector emphasis on communication services and defense technologies
• Fixed income strategy involves shortening duration with focus on intermediate maturities, underweighting corporate bonds due to historically tight spreads, and emphasizing US Treasurys and mortgage-backed securities
• Gold allocation maintained across all strategies driven by central bank buying and reserve diversification trends, with new platinum allocation in higher-risk portfolios citing favorable supply-demand fundamentals and industrial demand leverage

Summary: Confluence Asset Allocation Quarterly - Q3 2026 Outlook

Economic Outlook:

Confluence Asset Management forecasts low recession risk over the next three years, with US GDP growth expected near long-term trend levels. The Fed will likely maintain dovish policy to support risk markets, though inflation is projected to remain elevated at 2.5-3.5%, above the Fed's 2% target. The labor market shows gradual softening, with unemployment drifting higher from cycle lows as firms reduce labor hoarding through slower hiring rather than mass layoffs.

Equity Markets:

The firm anticipates broadening market leadership beyond mega-cap technology stocks, which face elevated valuations. They recommend maintaining US large-cap exposure while reducing mid-cap positions due to persistent passive flow concentration in index heavyweights. The "other 493" stocks present valuation opportunities after prolonged underperformance.

International developed equities are positioned for stronger relative performance, supported by fiscal stimulus abroad, valuation advantages, and expected US dollar weakness. The firm excludes US small caps due to headwinds from tariff pressures, higher financing costs, and limited pricing power.

New positions include overweight Communication Services sector and exposure to global metals/gold miners, anticipating demand from reshoring, defense spending, and energy transition investments.

Fixed Income:

Duration was shortened to intermediate-term, focusing on Treasuries and mortgage-backed securities. Corporate bonds remain underweighted due to historically tight spreads despite intact credit fundamentals. The yield curve is expected to gradually steepen as the Fed continues easing while longer-term yields stay elevated from fiscal debt issuance.

Alternative Assets:

Gold allocations continue across all strategies, supported by central bank buying and reserve diversification. Platinum was added to higher-risk portfolios based on favorable supply-demand dynamics and industrial demand leverage.