In “How Overvalued Are The Most Expensive Stocks?” I spent a few minutes editorializing around a slightly-more-nuanced measure of US equity valuations than what you tend to see in sundry “bubble” complaints.

The upshot was that if you group S&P stocks sporting the richest valuations and compare them to index constituents with the cheapest valuations, you come away with a visual that shows a roughly 200% premium for the former.

That sounds high, and it is. But it’s not nearly as high as it was in 2000 and 2021. Small comfort, I know, but worth noting because on a lot of other metrics, US shares are the richest they’ve ever been and on some measures of market concentration, we’ve surpassed the 2021 and 2000 peaks.

With that in mind, Goldman’s David Kostin ran a similar analysis for “Quality” stocks versus — and I’ll be polite — stocks that don’t score as high on a variety of familiar Quality metrics like, for example, balance sheet strength. There’s obviously quite a bit of overlap between Quality factors and the mega-caps.

Currently, the Quality factor itself and factors that are very often “seen with” Quality, are trading the richest they’ve ever traded versus their antipodes, as shown on the left, below.

On the right, you can see that the valuation premium for Quality stocks is much closer to the 2000 and 2021 extremes than the premium for expensive stocks versus inexpensive as discussed in the linked article above.

What you’re looking at on the right is actually an equal-weighted blend of Quality factors versus, um, “a basket of deplorables” (you gotta love it). The current premium, 57%, ranks 94%ile going back almost half a century. That premium’s typically something like 15%.

Are there implications for forward returns? Yes. And this is one case where the implied go-forward from the backtest is actually interesting, as opposed to just “interesting” because it’s a slow Thursday and I don’t have a lot else to tell you about. To be more precise, it’s not the go-forward itself that’s interesting, but rather the asymmetry.

There’s the chart, again from Kostin. The blended Quality factor has returned 10% or more over a rolling 12-month period (a one standard-deviation event) about 14% of the time looking back to 1980. The chart buckets performance using valuation premium.

When the Quality factor trades at a valuation premium to lower-quality names of 10% or less, the odds of a 10% return rose substantially — the frequency was 21%. On the other hand, when the valuation premium’s above 40%, as it is now, the historical instance of 10% returns over the next 12 months drops away entirely.

“The factor never generated a return of that magnitude when the factor was very expensive,” Kostin wrote. “Today’s 57% premium suggests the asymmetry of expected forward returns is skewed to the downside.”