When markets rise… but quality falls: a signal not to ignore

Since the beginning of the year, equity markets have generally performed well. Major indices are rising, investors seem confident, and volatility remains contained. However, behind this reassuring facade, certain signals deserve particular attention.

The factors: compasses for understanding the market

In equity management, style factors are powerful analytical tools. They allow companies to be classified according to fundamental or behavioral characteristics. Among the most closely monitored are:

Profitability: selects the most profitable companies, with solid margins and good capital management.
Risk: often exploited in the opposite direction, this factor favors stable, low-debt companies with low volatility.
Other factors such as Value, Growth, Momentum or Earnings Revisions complete this analysis framework.

Historically, these factors have all demonstrated their ability to generate long-term outperformance. However, in the short term, their effectiveness varies depending on economic cycles, monetary policies, and market behavior.

A worrying paradox: the market is rising, but the good performers are being penalized.

What is striking today is that the Profitability and Risk factors are clearly declining, even as markets are rising. In other words, the most profitable and least risky companies are being neglected, while more fragile, often more speculative, securities are attracting investment.

This phenomenon can be explained by several dynamics:

Seeking quick returns: in a context where a few large technology stocks capture the bulk of the performance, investors may be tempted to follow the trend, to the detriment of fundamental analysis.
Growing complacency: low volatility and the absence of recent shocks can create a false sense of security. This encourages some to take more risks, neglecting the quality of companies.
Fad effect: narratives around artificial intelligence or new technologies can overshadow traditional criteria of profitability or financial strength.

Why should we be worried about this?

Historically, periods when markets disregard the quality of companies often end in a harsh return to reality. When investors favor risky or low-yield stocks, the market becomes more vulnerable to a downturn because it rests on shaky foundations.

This discrepancy between overall market performance and that of fundamental factors can therefore be interpreted as a sign of complacency. It's not about predicting a crash, but about reminding everyone that caution remains essential, especially when performance drivers diverge from fundamentals.

Conclusion: diversify your analysis and remain attentive to the signals

In an environment where profitability and risk factors are neglected, it is essential not to be blinded by the overall performance of indices. A more nuanced factor analysis reveals that investors are currently favoring lower-quality securities, which can be a sign of vulnerability.

To navigate this environment, diversifying your analysis is crucial. Currently, the most relevant factors are earnings revisions and momentum, which reflect more immediate market dynamics and an ability to adapt to new information. These signals can help you better identify real trends, while maintaining a critical eye on portfolio quality.

Opinion piece by Michel Menigoz, Deputy Managing Director at Sanso Longchamp AM (LinkedIn).