U.S. equity strategists at Goldman Sachs, led by David Kostin, said the recent rebound in the “quality” factor — a basket of stocks characterized by high returns on equity, low leverage and stable earnings — remains limited by still-elevated short interest and a benign macroeconomic outlook that offers little incentive for investors to rotate back into defensive, high-quality names.
The quality factor has climbed roughly 4% over the past week, but that modest bounce follows a punishing 17% drawdown since July, marking one of the sharpest declines in recent years outside of the pandemic period.
Kostin’s team attributed the summer unwind primarily to a powerful short squeeze and a shift in investor appetite toward “low quality” stocks that are typically heavily shorted.
“A basket of the most shorted U.S. stocks has doubled since the market’s April low and rallied more than 30% since early September,” the strategists wrote in an October 24 report to clients. “The Quality factor typically struggles during short squeezes because low-quality stocks tend to be popular short positions.”
Macro outlook dampens quality rotation
Goldman expects modest U.S. growth acceleration and continued Federal Reserve rate cuts into 2026, conditions that reduce the relative appeal of defensive, high-quality equities. The bank forecasts a 7% rise in S&P 500 (SP500) earnings in both 2025 and 2026, with a year-end 2025 price target of 6,800 and a 12-month target of 7,200, implying limited upside from current levels.
Kostin noted that the Quality factor’s recent losses have overshot macroeconomic drivers by roughly 10%, suggesting the decline has gone “further than fundamentals alone would indicate.” Still, Goldman cautioned that neither economic data nor policy signals point to a near-term reversal.
“From a macro perspective…modest growth and easing policy give little reason for investors to rotate back to perceived safety,” the report said.
Valuations remain elevated
Despite the pullback, high-quality stocks continue to trade at rich valuations. Goldman’s analysis shows the long leg of its quality basket trades at 25 times forward earnings– more than double the 12 times multiple of low-quality counterparts. That places the valuation spread near its widest in recent years.
Within the quality universe, profitability and low-volatility factors remain especially expensive, while balance-sheet strength appears more reasonably priced.
Meanwhile, short interest in the S&P 500 (SP500) remains elevated, with a median 2.3% of market capitalization sold short — well above historical norms and leaving “room for the squeeze to continue,” according to FINRA data cited by Goldman.
High-quality bargains emerge
While the overall factor remains pressured, Goldman highlighted a subset of high-quality companies now trading at discounts after the recent selloff. These include members of the firm’s high-quality and quality compounders baskets such as Adobe (ADBE), Fiserv (FI), PepsiCo (PEP) and S&P Global (SPGI), which have fallen at least 10% below their 52-week highs and carry price-to-earnings ratios below their five-year medians.
The median stock in this group is projected to post 11% earnings-per-share growth in 2026, suggesting select opportunities for long-term investors despite the broader factor headwinds.
Earnings season: Strong beats, weak reactions
As of October 24, 29% of S&P 500 (SP500) companies had reported third-quarter results, with 69% beating analyst estimates by more than one standard deviation, well above the long-term average. Yet, the median stock that posted an earnings beat has underperformed the index by 33 basis points the following day, indicating that strong results have largely been priced in.
The coming week marks the busiest stretch of the earnings season, with roughly 44% of S&P 500 (SP500) market capitalization set to report, including major technology names such as Microsoft (MSFT), Alphabet (GOOG) (GOOGL), Meta (META), Apple (AAPL) and Amazon (AMZN).
Goldman Sachs sees limited near-term upside for high-quality stocks given stretched valuations, resilient short interest and a macro backdrop that favors cyclicals over defensives. However, the strategists suggest that recent underperformance may have created opportunities to accumulate select “quality compounders” at more attractive entry points.
While a broad rebound in Quality appears unlikely, individual high-quality stocks now trade at discounted valuations relative to their fundamentals, according to Goldman Sachs.