Quality stocks poised for a rebound

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Ryan Diamant, client portfolio manager, CIBC Asset Management 

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If we look at international markets and compare it to the broader investment universe, we can see that it actually doubled the performance of markets like the U.S. But if we look at performance for the various factors within international markets, quality significantly underperformed the broader market. And this is pretty surprising, given that quality has outperformed all other factors over the last decade. And what factors are used to explain is the performance over time. And so common factors are value, small cap, growth, [and] low volatility, among others, and what we observed throughout 2025 is quality underperformed all of those various factors. 

Now it was a very historic year for quality. If we look at something like the MSCI ACWI ex-U.S. Index, which is a common international benchmark, and we compare the relative returns of quality to that benchmark, it was actually the worst year for quality in history. If we look at something like the MSCI European Index, we get, once again comparing European quality to the broader market, this was the second worst year going back to 1987. 

And so it was truly a historic year for quality, in the fact that it underperformed all the various factors. And I think the reason behind its underperformance was [that] it was fairly expensive, as we had a significant outperformance of quality from 2022 to 2024. And around September of 2024, it was expensive and started to sell off. This continued into 2025, and so we found ourselves in the situation where we are today, where quality underperformed the broader market. 

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Why I think quality will outperform the market in 2026 is, first of all, if we look at 2025, what happened after Liberation Day was factors like momentum and value outperformed the broader market. And that’s very typical when you have a sudden rebound in economic growth that we saw post Liberation Day. 

But as we head into 2026, we’re expecting a broader market recovery, not just those value-related stocks or momentum, but the entire economy. 

In particular, the eurozone is expected to outperform growth expectations, especially where we were a few months ago. They have certainty in terms of where tariffs are going with the U.S., and so they can focus on economic growth going forward. 

In addition to this, we’re seeing increased fiscal spending in a lot of the different areas of the eurozone. 

For instance, Germany, earlier in 2025, announced that they would increase the debt limit to help fund initiatives like defence, infrastructure, and other energy initiatives. And so that should be a driver for performance in 2026. 

In addition to this, we’re also seeing deregulation in the eurozone. We’re at the early innings of this. It just started. But what we’re noticing is a lot of the red tape that has been implemented over the last decade in the eurozone is slowly being removed, and this could increase economic activity within the eurozone. 

So that’s the macro conditions that may help quality companies going forward. 

But if we look, yet again, at the quality index versus the broader market, in September of 2024 it was +1 standard deviation above its long-term average. Today, it’s —1 standard deviation below its long-term average. And so quality is now attractively priced, and that’s supportive heading into 2026. 

And then when you combine that with the fact that quality is expected to grow faster than the broader market throughout the next calendar year, then you get the perfect recipe for success. More attractive valuations and faster expected EPS growth is typically supportive for stocks in that type of market environment. 

In 2026, we expect quality stocks within international markets to grow anywhere from 7% to 8%, in comparison to the broader market at around 4%. And then within Europe, quality companies are expected to grow around 10% throughout 2026 in comparison to around 7% to 8% in the broader market. And so you have attractive macro conditions, attractive valuations for quality stocks going forward, and then faster expected growth as well. 

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I think a few company examples could be illustrative for this topic, and I wanted to provide two today. 

The first one being Ferrari. It’s a commonly known luxury sports car maker, and we’ve owned it within our international growth team at CIBC Asset Management for around 10 years. Now, after its IPO, the market was struggling to determine whether Ferrari was an automobile company or a luxury company, and we invested based on the fact that it is a quality luxury company. 

However the last year, it’s underperformed the market. It’s actually down 20% as of mid-December. And that’s on concerns of an economic slowdown in certain markets that it caters to, and concerns about luxury goods in this type of market. And this is the classic example of quality underperforming the market in this type of environment. But as I mentioned, growth is expected to pick up as we head into 2026, especially within European markets, and that should help companies like Ferrari. 

Another example is London Stock Exchange Group. They are a staple within global markets. They provide trading platforms and financial data. And a few years ago, they acquired Refinitiv, which is a competitor to Bloomberg. 

Now, with artificial intelligence really a key theme throughout 2025, London Stock Exchange sold off because many investors thought that artificial intelligence could replace a company like Refinitiv and London Stock Exchange Group. But in reality, a company like London Stock Exchange actually benefits from artificial intelligence. It could use developments there to access the vast amount of data it has on its platform and monetize around that. 

And so we actually think AI will be a benefit for London Stock Exchange Group, not a hindrance. And this is also going to help its already strong free cash flow growth, [and] its high returns on invested capital, which are key characteristics of a high-quality company. 

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How we identify quality companies is, first of all, you need to define what a quality company is. I don’t think any manager is going to come on this podcast and say they invest in low-quality companies. But to us, we define it as investing in companies who have strong margins and profitability, lower leverage, and high returns on invested capital. 

But I think there are also softer elements that you look for with quality. And I think that starts with behavioural finance: seeing how C-suite management teams react to various questions that you ask. Are they aligned with shareholders? And then in your following meetings, after you ask certain questions, do they follow through with what they said they would do? 

And so there’s a number of different ways you assess quality. But for us, on our international growth team, we think that we are experts at assessing controversy. And what that means is we conduct over 200 C-suite meetings per year, and on top of that, we early ‘due diligence’ companies. And so when you get a bit of a sell off in a company, we can better assess whether it’s transitory or enduring, and choose to invest. And so that company meetings element, plus the early due diligence allows us to avoid those quality traps. 

I’d say the second element associated with that is the fact that we run higher concentration, high-conviction portfolios. Then on top of that, our turnover is anywhere from 10% to 20%, so we can be highly selective in the types of businesses that we choose to invest in, and that, in addition to our company meetings, allows us to avoid those quality traps. 

Now the final element is flexibility, and we can invest in both developed markets [and] emerging markets. We can invest across market capitalizations. And so the flexibility to invest where the best opportunities are allows us to pick only the highest-quality businesses within their various sectors. 

And so for us, meeting with management teams, having high conviction and the flexibility to invest wherever we decide is the best opportunity for investors, I think, allows us to avoid quality traps within the markets.

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