Factor narratives Quality under pressure but the investment case remains intact

Factor narratives: Quality under pressure but the investment case remains intact

Ioannis Kampouris Michael (Xiaochen) Sun Head, Quantitative Strategies Director, Quant Capability, Client Portfolio Manager, August 2026|5 min read Quantitative Strategies, Eastspring Investments

Despite elevated market uncertainty in the first half of 2026, the quality factor recorded its worst performance in 60 years.

Markets shifted into a risk-on mode, rewarding cyclicals, higher beta and more speculative AI- linked names over companies with stable earnings, strong balance sheets and proven profitability.

We see no deterioration in Quality’s underlying fundamentals. This leaves the factor well positioned should market leadership broaden or economic conditions become less favourable.

Global equity markets experienced a volatile first half, marked by no shortage of unexpected events and uncertainty. In such an environment, one might reasonably have expected companies with strong profitability, robust balance sheets and resilient earnings to navigate the turbulence relatively well. The reality, however, has been quite different. As illustrated below, the cumulative return of the Fama–French Profitability factor has fallen to levels last seen during the dot-com bubble, marking the most severe drawdown in pure profitability in the last 60 years.

Fig. 1. Quality factor experienced its largest underperformance in 60 years (US)

Source: Eastspring Investments. Kenneth R. French - Data Library

We believe that there are three reasons why the quality factor underperformed:

1. Risk-on markets favoured cyclicals and higher beta stocks

One of the most consistent themes across sell-side and buy-side research has been the resilience of global economic activity in the face of geopolitical volatility and stubborn inflation concerns. Improving growth expectations encouraged investors to rotate into economically sensitive businesses rather than premium quality franchises. When markets believe that the economic cycle remains resilient and has further to run, the earnings momentum of cyclical businesses and the operational gearing of higher-beta stocks can offer more immediate upside than the steady compounding of quality. The defensive characteristics of quality, meanwhile, carry an implicit insurance premium that investors are often reluctant to pay in a rising market.

This pattern persisted even through March’s geopolitical shock. The conflict with Iran pushed oil above USD100 a barrel and briefly prompted a defensive rotation, during which Quality outperformed. The episode proved short-lived, however. Better-than-expected first-quarter earnings from the large US technology companies, together with upbeat guidance, quickly drew investors back towards the Artificial Intelligence (AI) trade and reinforced the prevailing risk-on backdrop.