Discover how JQUA targets a diversified exposure to quality businesses with high profit margins and reduced leverage levels to ensure that investors are not exposed to unwanted risks.
U.S. equity markets have delivered remarkably strong performance recently with the S&P 500 delivering 23% annualized returns over the past 3 years, supported by resilient economic growth, strong earnings growth, and persistent innovation leadership. However, the environment that powered outsized gains, characterized by concentrated returns, low realized volatility, and heavy reliance on a narrow set of mega-cap winners, is evolving. Historically, periods of elevated risk-adjusted returns tend to revert, offering lower returns and higher volatility than what investors have recently experienced. In fact, J.P. Morgan Asset Management’s 2026 Long-Term Capital Market Assumptions call for equity market returns that are less than one-third of what the S&P 500 has enjoyed over the past 3 years, with higher volatility.
Key themes looking ahead into 2026 and beyond are a more normalized return environment, market concentration and breadth, and frothy valuations particularly in US equity markets. While any sort of diversification away from market beta has not been rewarded or needed recently, investors should be reminded that passively buying broad benchmarks may expose investors to unstable companies and unwanted risks. Instead, investors may want to consider a strategy that targets the highest quality businesses with high profit margins and reduced financial risk. The JPMorgan U.S. Quality Factor ETF (JQUA) seeks to own the highest quality stocks in each sector, which can help investors to weather market downturns and also participate in upswings.
Why it’s high time for high quality
Quality is often used as a core allocation within portfolios given its tendency to do well in both up and down-market environments. During periods of market stress, quality has historically shown to be a ballast within diversified portfolios, consistent with the academic research and philosophy that more financially resilient companies are better equipped to weather economics storms. While quality tends to protect during market downturns, it also tends to provide meaningful upside participation during equity market rallies, with high quality companies typically underpriced relative to the rest of the market. While higher quality stocks by nature do present more defensively and lower beta than lower quality counterparts, periods of low-quality rallies where high quality misses out on strong upward performance tend to be short lived.
2025 was a tale of two halves for quality investors, with the tariff-driven market volatility early in the year providing an opportunity for quality to showcase its strength in protecting in a sell-off, with then the AI-euphoria driven rally in the rest of the year presenting a challenging backdrop for quality as speculative fervor in US equity markets prioritized growth expectations over profitability and financial risk measures.
The weakness in quality was not just a US phenomenon in 2025 as we saw high quality stocks underperform market cap weighted benchmarks across geographies. In fact, the UK was the only region in 2025 where quality stocks delivered higher returns than their 30-year average.
2025 marked the 4th most challenging year for the quality factor on a global basis from our measures, only surpassed by 2020, 2009 and 2003. Balancing the lackluster returns from last year with lessons learned from previous challenging periods for the quality factor, we observe that periods of low-quality stocks significantly outperforming higher quality peers does tend to be short-lived, and oftentimes is followed by some of the strongest performance periods for the quality factor as fundamentals re-emerge as a key driver of equity market performance. This has the potential to serve as a tailwind for higher quality stocks as we move through 2026.
Shifting back to the US, large cap returns have continued to be dominated by a handful of stocks with the concentration of those stocks within market cap weighted benchmarks reaching unprecedented levels. The “Magnificent 7” have accounted for at least 40% of the total return of the S&P 500 for each of the last three years.
With the benefit of hindsight, the dispersion in returns between the Magnificent 7 and the rest of the market can be somewhat justified when looking at the earnings growth dynamics between the two groups. Looking back over the past 3 years Mag 7 stocks have averaged 31% earnings growth while the remained of the index has only squeezed out a 3% earnings growth. However, as we look forward into 2026 and beyond, we see the potential for dispersion to narrow as earnings growth for the Mag 7 is expected to fall from the average over recent years as the remainder of the stocks in the index are expected to see stronger earnings growth than experienced recently. While these expectations don’t outright forecast challenges for the Mag 7 stocks, they do suggest that a more diversified exposure to US large cap stocks may be beneficial moving ahead.
Given the 86% cumulative total return over the past 3 years, US equities are at stretched valuations, with the 22.0x P/E of the S&P 500 as of December 31, 2025, coming in nearly 5 turns higher than the 17.1x average P/E over the past 30 years. This can leave allocators challenged to find inexpensive pockets of the market to invest cash in the new year.
Typically, in a later market cycle environment and particularly in a rate-cutting cycle, quality stocks move up in valuation and are frequently priced at a premium to the broad market as investors seek the comfortability and confidence that high quality stocks provide. However, currently US high quality stocks are less expensive than both their own long-term average and the broad market. This presents a unique opportunity for allocators to deploy capital to high quality stocks while not being forced to pay up for the exposure, akin to what we would typically expect at this point in the market and economic cycle.
Against this backdrop, JQUA’s focus on higher-quality, stable companies offers a solution for staying invested through the uncertainties that may present themselves in 2026 and beyond. JQUA seeks to:
- Manage risk and limit losses during volatile periods. Quality showed its strength in early 2025, navigating the volatile environment around Liberation Day and serving as a portfolio ballast. Going back to JQUA’s inception in November 2017, JQUA has successfully protected on the downside in all 4 periods of a 15% or more drawdown.
- Capture growth potential as markets recover. Quality stocks have historically outperformed the broad market across cycles, with less risk. Adding exposures now allows investors to access growth opportunities as they arise and enhance long-term return potential as we move through and beyond this market cycle.
Three-step process for constructing a high-quality equity ETF
As part of our suite of factor-based equity strategies, JQUA brings J.P. Morgan’s quantitative research, portfolio management, technology and trading capabilities to an ETF priced at just 0.12%. Rather than buy every name in the Russell 1000, the index targets the 200 to 300 highest-quality U.S. large cap companies across all sectors to offer similar sector exposure without the significant stock concentrations of traditional indexing.
Step 1: Align sectors with the market. JQUA’s process begins by matching the sector allocations of the Russell 1000, and realigning them back during each quarterly rebalance. We align sectors to the index to avoid sector bets and ensure that the exposure to high-quality companies is what drives the fund’s performance relative to the Russell 1000.
Step 2: Rank stocks within each sector. When determining the overall quality of each company, our rules-based approach ranks sector peers across 10 metrics based on three key quality pillars:
- Profitability – strong earnings and cash flow
- Financial risk – low leverage, high interest coverage, low share price volatility
- Earnings quality – consistent accounting practices
Step 3: Select and weight stocks. We own the highest-ranked companies in each sector and seek to avoid overconcentration, thereby reducing stock-specific risks while maintaining diversification and liquidity.
JQUA plays multiple roles in strong portfolios
With its targeted exposure to quality companies, JQUA aims to serve as a core holding alongside standalone value and growth strategies. It also aims to act as a core complement to round out existing portfolio positions or bolster overall quality exposure in one simple trade. Or consider it as a tactical allocation as outlooks change in today’s fast-moving markets.
Looking ahead, we expect to see increased market breadth and dispersion among company fundamentals as winners and losers emerge from the evolving economic backdrop. As always, we will look to improve on traditional beta by separating the most attractive stocks from the rest of the broad index.