The performance gap between high-quality U.S. equities and the broader market has widened, reaching levels last seen during the dot-com boom.
The S&P 500 Quality Index (SPXQUP)—a benchmark that screens companies based on strong balance sheets, high return on equity, and stable earnings growth—has lagged the S&P 500 by more than 11% over the past six months.
The last time this extreme divergence was seen was in April 1999. When it snapped back, it rallied to the other extreme, reaching a positive 20.6% by December 2000.
These high-quality index constituents tend to be profitable, conservatively financed firms with consistent cash flow. It is a stark contrast to the high-beta, speculative names currently driving index-level returns.
The disparity reflects a familiar pattern: investors crowding into fast-growing, momentum-driven technology stocks while leaving more stable companies behind. The current cycle, however, has a unique catalyst.
AI has propelled a handful of mega-cap tech companies to dominate market returns. Nvidia (NASDAQ:NVDA), whose earnings (reporting later today) became a make-or-break moment for the quarter, is the poster child of the boom. Meanwhile, other Magnificent Seven names continue to set record highs.
Quality-focused ETFs, including those tracking SPXQUP, own little or none of these companies, amplifying the performance gap. In some cases, Apple (NASDAQ:AAPL) is the only mega-cap tech constituent.
The late 1990s parallel is hard to ignore. Then, as now, a narrow group of high-growth technology stocks drove outsized market gains, leaving quality and value stocks behind. However, today's tech giants are far more profitable and entrenched than the unproven internet companies of 1999.
Still, the concentration risk—and the valuation stretch—echoes the earlier era. When the dot-com bubble unwound, quality stocks dramatically outperformed for years as fundamentals reasserted themselves.
Buffett's Blues
One company exemplifying today's quality underperformance is Berkshire Hathaway (NYSE:BRK). Warren Buffett's conglomerate is widely regarded as a proxy for durable, cash-generating blue chips. Yet, with a portfolio spanning insurance, railroads, utilities, consumer brands, and financials, Berkshire has struggled to keep pace with a tech-heavy benchmark. Its yearly gain of around 10% has also underperformed the broad S&P 500.
Part of the reason is structural. Buffett has maintained a cash-heavy position and minimal exposure to the AI-driven tech leaders. His longstanding philosophy of avoiding businesses he "doesn't understand" has left Berkshire holding relatively little of the Magnificent Seven—now roughly 35% of the S&P 500.
He has also reduced stakes in Apple and fully exited BYD (OTCPK: BYDDY), moves that may have limited upside during one of the strongest tech rallies in history. A recent bet on Alphabet (NASDAQ:GOOGL) looks promising but remains modest within the company's vast portfolio.
Yet, despite recent underperformance, history suggests quality's resilience tends to shine once speculative rally cools. With leading indicators cooling, the current divergence may prove unsustainable — just as it did the last time markets saw a gap this wide.
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