by AdvisorAnalyst Editorial Team
There is a paradox embedded in the current international equity landscape. The style factor with the strongest long-term track record — quality — has just endured one of its worst drawdowns in decades. And yet, according to Schroders' John Chisholm, that underperformance may itself be the most compelling argument for moving back in.
The analytical case is grounded in valuation spreads — a metric that measures the gap between the cheapest and most expensive stocks in the market. When that spread narrows to historically extreme lows, the evidence from nearly four decades of international equity cycles points consistently toward one conclusion: quality is about to reassert itself.
The Long-Term Case, and the Short-Term Pain
Quality investing, as Chisholm defines it, centers on companies that are "financially stable with low levels of debt and that generate strong, consistent levels of profitability." These businesses typically possess competitive moats, earn a healthy spread above their cost of capital, and — critically — enjoy strong reinvestment opportunities that allow them to compound returns across full market cycles.
Over the long term, the evidence is clear. Over 15–20 year periods across various cycles, quality has been a modestly outperforming style factor in international (non-US) equities. But recent years have been a different story entirely.
Chisholm is direct about the severity of the drawdown: "Amid geopolitical volatility, AI disruption and very short-term oriented, narrative-driven markets, quality has experienced one of its worst drawdowns in decades." The performance gap between quality and value in international equity markets has reached approximately 10% per year over the past three years. In EAFE specifically, quality has underperformed the broad market by 19% over that same window — a magnitude that historically has been rare and mean-reverting.
The Signal Hiding in Plain Sight
The core of Chisholm's argument is valuation dispersion — specifically, what happens when it hits an extreme low.
Valuation spreads measure the gap between the cheapest and most expensive stocks. A wide spread signals that investors are paying a meaningful premium for quality and earnings visibility, typically during recessionary periods. A narrow spread signals the opposite: investors are not meaningfully distinguishing between high-returning businesses and the rest. That complacency, Chisholm argues, has historically been the setup for quality's resurgence.
The numbers are arresting. Dispersion in developed international markets reached -0.85 standard deviations below the long-term average in January 2026 and sat at -0.79 at the end of Q1 2026. In the past 40 years, these levels have rarely been breached — and when they have, they've marked the floor. In the last four troughs of this nature, quality subsequently outperformed value by an average of 7.7% over the ensuing one-year period and 5.5% annualized over the ensuing three-year period.
The conclusion Chisholm draws is pointed: "While the performance momentum in value stocks has been exceptionally strong over the past few years, the extreme narrowness currently in valuation spreads would suggest that now is actually a good time to consider adding to quality."
What Could Catalyze the Turn
Chisholm identifies several macro conditions that could accelerate a rotation back toward quality: a cyclical slowdown, earnings downgrades, or credit stress — any of which he describes as having "a credible case" to materialize given the current backdrop.
The structural argument is equally relevant. "In the long term, it is always earnings that drive equity markets, but the market has recently experienced particularly acute policy distortions and a macro backdrop that has continued to favor cyclical beta, while stability and defensiveness have been discounted." As that distortion resolves, cash-generative, well-funded defensive companies — precisely the type quality strategies hold — stand to benefit.
Valuations themselves may also be enough to force the turn. "Valuations and valuation spreads are at extended levels, and that alone could be enough to initiate a change in market performance trends."
The Behavioral Trap to Avoid
Perhaps the most important message in Chisholm's analysis isn't quantitative — it's behavioral. "All too often we see investors fall into the behavioral trap of chasing performance and selling quality at the wrong time in the cycle." Recency bias, as he notes, causes investors to overweight recent events at the expense of long-term, forward-looking fundamental data.
Chisholm closes with Sir John Templeton's warning: "The four most dangerous words in investing are: 'This time it's different.'"
Forty years of international equity cycles, Chisholm argues, would suggest this time is not.
Key Takeaways for Advisors and Investors
- Quality's 19% EAFE underperformance over three years is historically anomalous and consistent with prior inflection points that preceded strong quality recoveries.
- Valuation dispersion at -0.79 standard deviations is near the historical floor — a level that has consistently preceded quality outperformance of 5–8% over 1–3 year horizons.
- The macro backdrop is shifting. Cyclical slowdown, earnings pressure, and credit stress are credible near-term risks — conditions that have historically favored quality's defensive, cash-generative characteristics.
- Behavioral discipline matters most at cycle turns. Chasing value momentum at precisely the point valuation spreads are signaling mean reversion is the classic performance-chasing error.
- The opportunity is specifically in non-US equities, where the quality drawdown has been deepest and the valuation setup is most compelling.
Footnote:
1 Chisholm, John. Schroders. "Could it be time for a resurgence in quality?" 25 May 2026.
