December 2025
“I will honor Christmas in my heart, and try to keep it all the year. I will live in the Past, the Present, and the Future.” These are the redemptive words of Ebenezer Scrooge in Charles Dickens’ A Christmas Carol. While intended as a pledge of personal reformation, they serve as surprisingly good advice for the modern investor, who’s often obsessed with the immediate gratification of the latest trend. The Ghost of Markets Present seems to love almost anything related to artificial intelligence (AI). AI-related spending accounts for more than half of U.S. GDP growth this year, and the tech-heavy NASDAQ Composite Index is up 24% for the year, as of the date of this writing.
Unfortunately, this infatuation with AI has come at the expense of many high-quality companies. After all, it’s hard to pour money into a theme or sector without taking it out of somewhere else. Granted, quality is a subjective term, but for the purposes of financial markets, it’s generally defined as companies that are consistently profitable, with low levels of debt and sound accounting practices. In fact, the S&P 500 Quality Index, which is comprised of the 100 highest-scoring companies in the S&P 500 Index based on quality metrics, is suffering its worst year of underperformance since 1999.
Though the past cannot always be relied upon to predict the future, if the Ghost of Markets Past could teach us anything, it would be that quality eventually matters. Over the past 30 years, the S&P 500 Quality Index has outperformed the broader S&P 500 Index with a difference in cumulative return of 902%!
The Quality Paradox
Since the carnage of “Liberation Day”—the moniker for the massive tariff shifts earlier this year—investors have been in a “risk-on” frenzy. Buying sprees come in all shapes and sizes, but this one will be remembered for its affinity for “ugly” stocks. From the market bottom of April 8th this year, high-quality stocks in the S&P 500 have underperformed the index by roughly 10%. The trend is worse if you look at smaller public companies. Small-cap companies with negative earnings have outperformed their profitable peers by roughly 20% over the same time period! Likewise, the Financial Times recently noted that “unprofitable tech” stocks are up nearly 70% in 2025… far outpacing the major averages.
We call this the “Quality Paradox.” Logically, companies with resilient balance sheets and sustainable profitable margins should command a premium, especially in uncertain times. As a multiple of earnings, quality stocks are currently trading at a 30% discount to the broader market. That is a staggering gap. We haven’t seen a valuation disconnect like this since the tail end of the Dot-com Bubble in the early 2000s.
Spirit! Remove Me From This Place—I Cannot Bear It!
There are several possible explanations for this odd market behavior. One argument is that AI will be such a transformative technology that one would want to own those companies that are “betting the house” on it, even if that bet comes at the expense of current profits and indebtedness. An alternate theory is that we’re witnessing the tail end of a long bull market. During these late stages, risk taking peaks and investors “reach” to bid up low-quality companies. And last, some believe that this is a signal that monetary and fiscal stimulus are setting the stage for a friendly backdrop for corporate America next year, thereby sparking investors to seek the weaker companies that are likely to benefit disproportionately from an accommodative economic environment.4
Such extreme dislocations between high- and low-quality stock performance are typically short-lived. The CFA Institute recently published a fascinating study on this exact dynamic. They found that while quality shares can underperform in short, speculative bursts, they significantly outperform the broader market over the long run. The data shows that the longer your time horizon, the more quality dominates. Over rolling 10-year periods, the MSCI World Quality Index has outperformed the MSCI World Index in every month since 1995 (361 observations!).
Not If, But When
We try to avoid statements of certainty, but we’re pretty sure we know what the Ghost of Markets Future will favor. Quality shares have outperformed the broader market for decades, and we feel confident that this pattern will resume at some point. The timing, as always, is a bit trickier to predict. Market psychology is a powerful force, and the “animal spirits” driving unprofitable stocks higher could persist for another quarter, or perhaps longer.
Nonetheless, we pride ourselves at Hamilton Point on being patient investors. Periods of underperformance are painful to suffer through, but we’d prefer that to spending our nights worrying about owning companies with excessive debt or tenuous business models. Moreover, now is exactly the time we’d be particularly concerned about such companies. Uncertainty is a market constant. Still, it feels as if we’re living through an extraordinarily uncertain time. Each week brings new headlines of circuitous multi-billion dollar spending arrangements between tech giants. The labor market is clearly weakening. There will be a new Fed president in six months. The One Big Beautiful Bill will soon be adding stimulus to an economy that is still recovering from a recent period of inflation, as well as worsening the country’s fiscal deficit. Many of the existing tariffs may be deemed unconstitutional. Far from an exhaustive list, but these are just a few of the developments that could cause the economy to materially improve or weaken next year.
Returning to our Christmas Carol theme, perhaps the most important lesson of the novel is to give thanks for those close to you. In that spirit, we wish you and your families health and prosperity in the year ahead. We are thankful for the countless relationships we have formed with many of you during our eighteen years in business. Happy holidays, and as always, we welcome your conversation at any time.
All market data is sourced from Bloomberg unless otherwise stated. 1. The S&P 500 Quality Index was launched on July 8, 2014. All information presented prior to the index launch date is back-tested. Back-tested performance is not actual performance, but is hypothetical. The back-test calculations are based on the same methodology that was in effect when the index was officially launched. However, back-tested data may reflect the application of the index methodology with the benefit of hindsight, and the index returns do not reflect the deduction of any fees or expenses. Past performance is not an indication or guarantee of future results. The commentary is for informational purposes only and the opinions expressed herein are those solely of Hamilton Point. Hamilton Point reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs. There is no assurance that any securities or strategies discussed herein will be included in or excluded from a client portfolio. It should not be assumed that any of the securities, strategies or internal studies discussed were or will prove to be profitable or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of the securities discussed herein. An investment in our strategies is subject to investment risk, including but not limited to, the loss of principal and may not be suitable for all investors. This is not a recommendation to buy or sell any particular security and should not be considered financial advice. Past performance is not indicative of future results. A full description of Hamilton Point and its investment strategies and advisory fees can be found in Hamilton Point’s Form ADV Part 2 which is available upon request or at the Investment Adviser Public Disclosure website. Hamilton Point is an investment adviser registered with the U.S. Securities and Exchange Commission, though such registration does not imply a certain level of skill or training. Hamilton Point’s principal place of business is in the State of North Carolina. HP-25-76