By Jacob Sonenshine

"Quality" stocks are supposed to perform well in a volatile market. That hasn't been the case this year.

This year's market has certainly been volatile. Between President Donald Trump's tariffs, the debate over the "One Big Beautiful Bill," and the war between Israel and Iran, it has been a choppy ride for the S&P 500, which has managed a small gain this year despite a 19% drop earlier this year.

That's where quality stocks should help investors. With competitive moats around their businesses, high margins, and consistent profits, these are the steadiest of the steady. It doesn't hurt that many of them are from defensive sectors like consumer staples, utilities, and healthcare, which tend to be able to maintain their business even when the economy slows. Quality sometimes outperforms the market when it's concerned about the economy, but at the least, tends to hold its ground and trade with minimal volatility.

Not this year. The iShares Edge MSCI USA Quality Factor exchange-traded Fund has dropped 0.4% including dividends in 2025, while the SPDR S&P 500 has returned 2%.

The problem: Some high-quality companies don't seem so high quality right now. Eight stocks in the ETF, accounting for more than 10% of the market value in the fund, are down 5% or more this year, including a few double digit blowups.

Four losers standout. First, there's PepsiCo, which is down 15% this year. Today, it's still categorized as "high quality" because of its scale -- it's worth $177 billion -- high margins, stability, and consistent earnings to date. But recently, it hasn't traded as if those attributes are a lock. It's down 32% from its record high in early 2023.

Analysts have reduced 2025 sales and earnings estimates, as top-line growth has slowed into the low single digits. Many are starting to wonder if increasing health consciousness from consumers is e ating into PepsiCo's market share, particularly at Frito-Lay, which accounts for almost a third of the company's revenue. Millions of people are on GLP-1s, which reduce people's appetite for junk foods, while low-carb and high-protein brands are growing. The market is concerned that the future will bring about inconsistent earnings and slow growth.

Merck, meanwhile, is down 20% this year. To date, its earnings have been consistent, mostly because patients need their drugs, so economic turbulence doesn't reduce the company's earnings. It, like other large pharmaceutical companies, has operating margins that are more than twice the aggregate margin for the S&P 500.

Merck's earnings haven't declined recently, but the market is pricing in slow or stagnating growth for the long-term. The stock's multiple of expected earnings for the coming 12 months has dropped to just under 9 times from almost 11 times to start this year.

Merck doesn't appear to have another blockbuster on the horizon, nor does it have an obesity drug to compete with Eli Lilly. Obesity is a fast-growing business, and if Merck doesn't grab its share of it, management will have to find other drugs to sell. It hasn't done much off that recently.

Elsewhere, Adobe is down 15% this year, including a 5% fall the trading day after its June 12 second quarter earnings report. The stock's multiple has tumbled sine the end of December because, even though the earnings are growing, the market hasn't seen enough evidence from the company's guidance that the company can maintain its growth for the long-term. It's not convinced that Adobe is one of the more competitive software companies using artificial intelligence to enhance its offerings.

Then there's UnitedHealth Group, which is down 40% this year. Historically, it's seen as high quality because people never stop spending on health insurance. But this year, analysts have reduced sales and earnings estimates. Unfavorable regulation could lift costs, while a fraud investigation remains ongoing.

It's generally smart to invest in high quality stocks, but not all of them will succeed. Investors still must to pay attention to which companies are likely to sustain their momentum -- and maintain the traits that made them quality companies in the first place.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com

This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.

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June 23, 2025 11:09 ET (15:09 GMT)

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