High-Quality Stocks Fumbled Without AI. Own Them Anyway.

The Invesco S&P 500 Quality ETF owns Apple but lacks Nvidia, Microsoft, Amazon, and Alphabet. (JUNG YEON-JE/AFP via Getty Images)

Key Points

• Quality stocks significantly underperformed the broader market in the third quarter, with the Invesco S&P 500 Quality ETF gaining only 3%.
• Underperformance of quality stocks was attributed to a heavy reliance on poorly performing consumer staples and a lack of Big Tech/AI exposure.
• Despite recent underperformance, some experts anticipate a comeback for quality stocks, citing reasonable valuations and potential interest rate cuts.

So much for owning dependable stocks with solid earnings and healthy balance sheets.

So-called quality stocks lagged the broader market in the third quarter. And they trailed riskier companies, growth stocks, and small-caps by a particularly wide margin, according to an analysis from The Leuthold Group.

Scott Opsal, director of research and equities for Leuthold, noted in a report Monday that the , iShares S&P 500 Growth , and Invesco S&P 500 High Beta Index exchange-traded funds sported returns of 9.1%, 9.8%, and 12.9% respectively in the third quarter. But the Invesco S&P 500 Quality ETF was up just 3% from July through September. The Vanguard S&P 500 ETF rose 8.1% during the same period.

So why did quality stocks underperform by such a wide margin? Chalk it up to a heavy reliance on poorly performing consumer staples stocks such as Coca-Cola, Colgate-Palmolive , Costco, and Procter & Gamble, which all tumbled in the third quarter.

“Staples includes many brand-name powerhouses that rightly belong on any list of high-quality stocks, but blue chips are feeling no love from investors in this growth-powered bull move,” Opsal said. “As the only sector to record a negative return in Q3, staples was the proverbial millstone around quality’s neck.”

A lack of Big Tech/artificial-intelligence star power didn’t help either. While the quality ETF does own Apple as its largest holding, the fund doesn’t own any other Magnificent Seven stocks. That means no Nvidia, Microsoft, Amazon, or Alphabet. It also doesn’t hold Broadcom or Oracle. So the quality ETF “suffers from missing out on the AI mania,” according to Opsal.

Making matters worse? Some of the tech names that are in the quality ETF each fell more than 10% during the third quarter—software names Salesforce, Adobe, and Intuit, which all suffer from the perception their sales and earnings will be hurt by AI.

Does this mean investors should steer clear of quality stocks? Not necessarily. In fact, the quality ETF is off to a solid start for the fourth quarter, rising about 2% since the end of September. That is roughly in line with the S&P 500’s gain.

Staples stocks also could rebound in the months ahead, given the expectation the Federal Reserve will continue to cut interest rates. That should make high-dividend yielding consumer stocks more attractive if bond yields fall. In fact, Leuthold’s Opsal noted that the ProShares S&P 500 Dividend Aristocrats ETF was another laggard in the third quarter, gaining just 3%.

Others argue the market rally has started to broaden this year—lifting small-cap stocks. That should continue and benefit quality companies as well.

“Value may come back into popularity. That’s not a negative about large cap growth, but other stocks out there are much more reasonably priced,” Scott Welch, partner and chief investment officer with Certuity, told Barron’s.

Along those lines, Invesco’s quality ETF now trades at 22 times earnings estimates for next year, in line with the S&P 500, while the iShares S&P 500 Growth ETF trades for just under 28 times 2026 profit forecasts.

Lamar Villere, a portfolio manager with Villere & Co., also thinks quality value stocks will make a comeback. He told Barron’s his firm recently bought shares of Tylenol-maker Kenvue because he thinks the selloff due to comments made by President Donald Trump linking the use of Tylenol during pregnancy to autism in children is overdone. Kenvue now trades for just 13 times earnings estimates.

Villere said his firm also bought more shares of software company Roper in the third quarter and he likes reasonably valued large-cap techs Microsoft and Amazon.

“We’re counting on a quality comeback, growth at a reasonable price,” Villere said. “Betting on perfection is a dangerous place to be in so we’ve been reticent to pile on to the momentum trades.”

That seems like a prudent move as the broader market continues to hit new highs. Investors with more diversified portfolios will be glad to have a greater mix of quality stocks once there is an inevitable pullback in the momentum trade.

Write to Paul R. La Monica at paul.lamonica@barrons.com