As we close out another year, we acknowledge it has been a difficult one for fundamental investors focused on quality companies.

How does Global Alpha define “quality”?  We mean companies with:

• Revenue growth with a high portion of recurring revenues
• Healthy profit margins
• Strong balance sheet
• Dividend paying
• Fair valuation, ideally below the market multiples

Instead of quality, the market has been fixated on size (the bigger, the better), liquidity (the more liquid, the better) and momentum (what goes up will continue to go up).

In other words, it’s a very speculative market.

Are we in a bubble?

Ruchir Sharma, Chair of Rockefeller International, asked that exact same question in his piece in Financial Times – The four ‘O’s that shape a bubble. He described four characteristics that define a bubble, “four Os”: overvaluation, over-ownership, overinvestment and over-leverage. In our view, today’s market checks all four boxes.

Overvaluation

Consider the S&P 500 price-to-sales ratio. It is currently at an all-time high, well above the peak reached during the tech bubble in 2000. The market is paying record prices for each dollar of revenue.

Source: Bloomberg

Over-ownership

US household stock ownership, as a share of financial assets, is also at record levels. According to Gallup, about 165 million Americans – roughly 62% of US adults – own stocks, an all-time high.

On top of that, foreign investors now hold a record share of US equities. The market has rarely, if ever, been this “crowded.”

Source: Federal Reserve

Sources: Federal Reserve, Macrobond, Apollo Chief Economist

Overinvestment

Technology investment has recently surpassed 6% of US GDP, eclipsing the previous record set in 2000. But the ultimate return on these investments is still uncertain, and there are signs that adoption is slowing rather than accelerating.

Over-leverage

We often hear about the enormous cash balances of the “Magnificent Seven.” However, much less attention is paid to the other side of their balance sheets: liabilities.

Amazon, Meta, and Microsoft are now net debtors, and they are increasingly financing capital expenditures with debt.

So, all four Os suggest a bubble. But who are we to know?

Surely, this time, it’ll be different! Right?

We recently looked at some assumptions underpinning the current enthusiasm and valuations.

The general consensus is that global semiconductor sales will grow at an annualized rate in the mid- to high-20% range over the coming decade.

During the strongest period until now – the 1990s, with the advent of the personal computer and the internet – annualized growth in semiconductor sales was about 15%.

Once again, the narrative is that “it’s different this time.”

What could deflate this bubble?
If we had to name one catalyst, it would be Nvidia, now the largest company in the world by market value, the most owned and traded stock globally, and the poster child for the AI wave.

What could go wrong with Nvidia?

In a word: Competition. More competition would likely mean lower market share, lower prices and lower profit margins.

Lessons from Novo Nordisk

The chart below shows the stock price of Novo Nordisk, which was the largest European company by market value just over a year ago. As a leader in GLP-1 “miracle drugs” used for weight loss and other health benefits, Novo Nordisk became the market’s favourite story.

As competition intensified and prices came under pressure, Novo Nordisk experienced a dramatic shift: its market value has dropped by 68% since its peak in June 2024.

What happened to this market leader?

Simple: more competition and lower prices. In 2024, Novo Nordisk earned €24.48 per share, up 29% from 2023. By mid-2024, analysts were expecting earnings of €30 per share in 2025, implying another 23% growth.

Source: Bloomberg

Source: Bloomberg

Instead, according to Bloomberg consensus estimates, earnings for 2025 will be around €23.38, a decline of approximately 4.5%, with a further decline expected in 2026. Novo Nordisk remains a great company, investors have just overpaid for it.

Lessons from Cisco

At the peak of the dot-com era, Cisco Systems was the company that defined the Internet age. It was the most valuable company in the world at the start of 2000, supplying the routers needed to handle internet traffic that was doubling every few months.

Despite that dominant position, Cisco’s stock only just regained its 2000 peak price last week – more than two decades later.

Source: Bloomberg

Looking at past trends, we do not expect Nvidia to maintain the market share and pricing power implied in current analyst forecasts. In our view (shaped by history that competition, regulation and changing narratives eventually catch up with even the most celebrated leaders), it is more prudent to diversify and pivot back to high-quality, reasonably valued companies with durable earnings and strong balance sheets

Lastly, we encourage you to read our previously published piece on quality: Time to take out the trash – Why high ROE matters in the long run. We breakdown how quality outperforms in the long-run and why it matters as an allocator.

We wish you a happy holiday season to you and your loved ones.

May 2026 bring peace and happiness to the world.

After the “meme stock” frenzy of 2021 and a bruising surge of volatility in 2022, many investors assumed retail traders had finally stepped back. The story was neat: higher rates, tighter liquidity and fading stimulus would restore rationality to equity markets. We were not convinced and argued in February 2023 that speculative behaviour was more likely to adapt than disappear.

Fast forward to today, and the data suggest retail participation has not only persisted, it has become a defining force in short‑term market moves. Across the small‑ and mid‑cap universes, trading volumes in lower‑priced, lower‑quality names have surged, with roughly a quarter of daily volume now concentrated in stocks trading under $5, a share last seen at the peak of 2021’s speculation. This renewed activity has driven a striking rotation beneath the surface: low ROE and even unprofitable companies have periodically outpaced their higher‑quality, high‑ROE peers over short horizons.

In this weekly, we want to address two questions:

1. Why does high ROE – the best proxy for quality – matter when investing? And,
2. What does history tell us about the performance of companies with high ROE versus those with low or negative ROE?

What ROE really measures

Return on equity (ROE) is net income divided by shareholders’ equity; it tracks how efficiently a business converts owners’ capital into earnings. In practical terms, it tells you how many dollars of profit a company generates for every dollar of equity on its balance sheet. Conceptually, ROE links back to basic valuation logic: for a given starting multiple, a firm that can earn and reinvest at higher rates should grow intrinsic value and future dividends faster over time. A company that compounds book value at 15–20% per year for a decade ends up in a very different place than one compounding at 5%, even if both start at the same size and valuation.

High – and sustainably high – ROE typically reflects one or more durable advantages: strong pricing power, an advantaged cost position, valuable brands or networks, or business models that require relatively little capital to grow. This is why investors often group high-ROE companies under the broader “quality” or “profitability” factor. In other words, ROE is not just a ratio; it is often a shorthand for underlying business quality.

Why high ROE wins over time

History is clear: profitability and quality matter far more over multi-year horizons than they do over six month “junk” episodes. Portfolios tilted toward companies with high and persistent profitability have historically delivered higher average returns than portfolios concentrated in low profitability or unprofitable names, even after controlling for size and valuation.

There are three main reasons for this:

1. Compounding of retained earnings: High-ROE companies can reinvest a larger portion of each dollar of earnings at attractive rates. Over time, this drives faster growth in earnings per share and intrinsic value without requiring fresh capital from shareholders.
2. Resilience through cycles: Businesses that earn high returns on capital usually have competitive advantages that help them sustain margins and cash flows during downturns, which tend to show up as shallower drawdowns and faster recoveries.
3. Better capital allocation options: Management teams leading high-ROE franchises often have more flexibility: reinvest in the core, expand into adjacencies, pay dividends or buy back shares. Lower-quality companies, in contrast, often need to issue equity or debt simply to survive, diluting existing shareholders.

Short periods of outperformance by low-quality stocks can be sharp and uncomfortable, but they have historically been transient, while compounding fundamentals tend to dominate over longer horizons.

When you think about it, the lesson for long-term investors couldn’t be clearer: real wealth comes from investing in companies that steadily compound capital at high rates, not from jumping on every fleeting speculative surge. The junk rallies fade and quality compounding lasts.

Time to take out the trash – What really is a “junk rally”?

In a universe of over 12,000 companies within global small caps, not every balance sheet is one to admire. Our job as active managers is to find real quality – the companies that actually make money and know how to grow it – and to avoid the companies that are overleveraged, poorly managed or structurally unprofitable. Many of those “junk” businesses feel more like ticking time bombs than investments. So, what happens when these so‑called junk companies rally and drive index performance? Do we simply throw in the towel and chase them?

A junk rally is a period when the lowest‑quality stocks – often those with excessive leverage, negative earnings, high beta or heavy short interest – significantly outperform the broader market, particularly higher‑quality names. These episodes tend to be most intense and momentum‑driven in small caps, where smaller market caps and thinner liquidity allow collective enthusiasm and buying pressure to move prices disproportionately.

Junk rallies often arrive with a burst of excitement – usually from retail investors – as they rush into stocks chasing a story and paying little attention to fundamentals. To spread these stories, investors turn to platforms like Reddit, X or Instagram, using viral posts and online communities to build momentum. As more buyers join in, the rally feeds on itself, with price action attracting even more attention.

Common terms around these episodes include:

• Diamond hands: Investors who refuse to sell, convinced that holding long enough will eventually make them rich.
• Short squeeze: When heavily shorted stocks rise sharply, forcing short sellers to buy back shares to cover positions, which drives prices even higher.
• FOMO (“fear of missing out”): The anxiety investors feel when they believe they might miss a big gain if they do not act immediately.
• Pump and dump: When prices are hyped up – often by coordinated online promotion and early movers sell into the frenzy, leaving late buyers exposed when prices fall back.

These phrases rarely appear in institutional memos, but the behaviours behind them very much exist in our universe and often bring sharp, sudden volatility to stocks whose fundamentals have not changed.

How junk rallies behave in practice

Over the past five years, we have seen several junk rallies – wild bursts where low‑quality stocks suddenly take off. Each time, two features have stood out. First, these rallies are typically parabolic and short‑lived; trying to jump on the bandwagon after the move is underway is almost always a poor risk‑reward trade‑off. Second, they almost always mean‑revert back toward the market, making them more about timing and positioning than about sustainable value creation.

Normally, we would pay limited attention to these episodes. However, because these lower-quality stocks sit in our benchmark, big, synchronized rallies in some low-quality pockets can cause us to lag temporarily. That is exactly what happened in 2020, 2023, and again in 2025, when risk on sentiment sent the lowest quality corners of the market flying while our quality growth names took a back seat. As the excitement faded and fundamentals reasserted themselves, excess junk gains unwound and quality leadership reemerged.

Proof that low quality doesn’t last

Even without decades of data, recent episodes make the point: high ROE remains a long‑run winner. In the 2022 low‑quality rally, high‑quality stocks temporarily lagged as low‑quality names spiked and then sold off, but by the end of that six‑month stretch, the high‑quality cohort had again moved ahead. You saw a similar pattern in the quality rally of summer 2024, which lost steam by early 2025, and more recently in the post‑Liberation Day rebound, where relief from macro fears and crowded positioning turbocharged the most speculative, lower‑ROE parts of the market.

Once low quality lost steam, high quality rebounded faster

Low quality was ahead, but high quality protected during Liberation Day market correction

In the immediate aftermath of Liberation Day, low‑quality stocks rallied because the market shifted violently from fear to relief: investors moved quickly from pricing in severe recession and trade dislocation to betting on a softer outcome, and that swing in sentiment tends to benefit the most beaten‑up, highly levered and high‑beta parts of the market first. Positioning and mechanics amplified the move, as many lower‑quality names were heavily shorted and under‑owned going into the shock, so even a modest improvement in the macro narrative forced short covering and factor rebalancing, turbocharging returns in exactly the sort of speculative companies that typically lead junk rallies.

The current junk rally is showing signs of losing momentum, with lower-quality names starting to lag

Don’t hate the player, hate the game

Now that we’ve defined what junk rallies look like, let’s examine how they affect active management. As noted above, the post-Liberation Day period – when the MSCI World Small Cap Index surged 34.3% (CAD) between April 8 and October 31, 2025 – marked one of the strongest low-quality rallies of the past decade. During this time, market leadership – particularly in the United States – was dominated by lower-quality companies across a range of sectors. The AI and data centre trade became the theme of the year, driving performance regardless of valuations or ROE.

What you’ll almost never hear an investor say is that they’re overweight “junk.” It’s rare for anyone to deliberately focus on low-quality companies. As a result, low-quality rallies usually lead to short-term periods where active managers struggle to generate alpha. Looking at year-to-date and one-year returns, we’re seeing exactly that type of environment. With the MSCI World Small Cap Index ranking in the middle-to-high second quartile, about 60% of active global small-cap managers haven’t added alpha over the past year. Additionally, these periods usually come with a wide dispersion in manager returns, as portfolios with even modest exposure to the most speculative names tend to outperform sharply, while quality-focused strategies are left behind.

As we can see below, over the 7- and 10-year periods, global small caps remains an inefficient asset class – with more than 50% of active managers outperforming the MSCI World Small Cap Index.

What we’re trying to argue is that when these short periods of low quality take over, don’t hate the player, hate the game. The small cap market can be dysfunctional for short stretches, but over the long run, high-ROE companies almost always outperform their low-ROE peers.

It’s no secret that public finances in most of the markets Global Alpha covers are in a dire state, and one of the common culprits is usually pensions and other retirement benefits. Countries such as France and Italy spent roughly 15% of GDP over each of the last two years and are on average the second largest item after health care. Many countries are having to increase retirement age to alleviate the strain, and less than 30% of Gen Z expect to retire with similar retirement benefits than older generations.

In the 90s, Australia took its own unique approach to ensuring retirement-system sustainability through the development of the superannuation system. It is a mandatory savings scheme where employers are required to fund a minimum percentage of an employee’s salary into a superannuation fund on their behalf. Employees are then able to invest the amount on their own if they choose to and start withdrawing it at 65. This simple approach created one of the largest pension systems in the world with $4.1 trillion in assets, where employers contributed $147 billion in the last year. The Super Guarantee threshold, the percentage of salary employers must deposit, has once again increased this year to 12%.

Given the high expected retirement assets, it’s no surprise that Australian retirees have had a willingness to tolerate higher risk in their asset allocation while asset classes like annuities have seen a lower adoption rate compared to other developed economies. While the population is overall still young compared to the United States, there is a growing concern among experts that too much risk is being taken by individuals that cannot afford it. Regulators and policymakers in recent years have taken several steps to attempt to address the problem:

• Implementation of Retirement Income Covenant in 2022 requiring superannuation trustees to put additional emphasis on diversification and flexibility and increase educational resources.
• Friendlier mean-test treatment for lifetime income streams to improve middle-class retirees’ wealth and therefore reduce the need for risk-taking to reach retirement goals.
• Consultation on potential changes to capital settings and requirements for annuity products, with the aim of reducing capital intensity of insurers and allowing for more competitive pricing and supply, therefore making the product more attractive as part of an asset allocation.

We recently initiated a name that gives us exposure to this dynamic: Challenger Limited (CGF AU). The company operates both an APRA‑regulated life division (annuities and related longevity solutions) and a multi‑manager funds management arm (Fidante and Challenger Investment Management). Challenger manages $130 billion in assets.

As mentioned, annuities as an investment product in Australia has some of the lowest adoption rates of all developed countries at 2% vs. 15% for Japan and 20% for the United States. While some of this difference can be explained by demographics, the reality is that regulatory capital intensity for annuity providers has been much higher than other countries (meaning their pricing ends up worst) and education on the product has been lacklustre. What piqued our interest in the Challenger story is that the Australian Prudential Regulation Authority (APRA) has announced steps to address these problems as it seeks to encourage workers to include an annuity allocation in their retirement savings account. Some of the steps proposed by APRA to reduce capital intensity are now clearer. In 2025, APRA confirmed a consultation to change the treatment of the illiquidity premium, with the stated intent to lower capital requirements for annuity products when risk controls and asset‑liability matching are robust. If implemented as outlined, this would make pricing more competitive and broaden supply without compromising solvency standards.

As the dominant player in the annuity market, with a market share estimated around 90-95%, Challenger has been one of the more influential and proactive companies in providing feedback to the regulators and there are reasons to believe that regulators are using Challenger’s data to evaluate the impact of potential changes.

Even without betting on regulatory changes, Challenger has plenty of things going for it. The core annuity business in Australia is growing nicely as they are consistently landing new mandates with super annuities (which are being urged to provide their members with more guaranteed income products), the annuity book duration is increasing (allowing for higher margin/investment return), their unique Japan exposure is showing strong momentum (and they are expected to land another distributor in the near future) and the firm is launching new products both on the annuity and investment side which appear to be showing initial success.

One of the advantages of taking a global view on investing is that it allows us to find differentiated stories in a space we typically would not be overly excited about. Life insurance companies in Europe or the United States tend to exhibit bond-like features, being highly defensive and providing decent cash-flow. Meanwhile, Australia built one of the most successful retirement savings engines globally and is set to benefit from a large demographic tailwind that should see life insurers like Challenger benefit over the next decade, in addition to having regulatory tailwinds and policymakers’ support.

The Spanish economy has been the star performer in Europe recently, and consequently its principal stock exchange has also produced the best returns. In this week’s commentary, we look at the underlying reasons behind the performance of both the economy and stock market, as well as some of Global Alpha’s holdings in the country.

The Spanish economy grew over 3% in 2024, and another 2.7% of growth is forecast for 2025 which is significantly more than other advanced economies in Europe. The European Central Bank is forecasting 1.2% growth for the euro zone this year. Spain has seen its credit rating upgraded in recent weeks, in stark contrast to other large, developed economies such as the United States and France, which have recently seen their credit ratings downgraded.

A significant factor of this star performance is how the demographic situation in Spain is different from its peers. While the general movement in Europe has been toward more restrictive policies on immigration, Spain’s border has remained more open. The majority of the 600,000 average annual net inflow of immigrants are of working age which has resulted in record levels of employment (yet still the EU’s highest unemployment rate) and means Spain is not experiencing the labour shortage found elsewhere in Europe. A secondary effect is the increase in domestic consumer spending. Given that most immigrants are coming from Latin America, a shared language and culture have been key in the integration and, more importantly, acceptance into society. Most of the jobs being filled by migrants are in hospitality and construction, so there is more to be done to attract workers in high-end service sectors.

Spain has been, and continues to be, a prime beneficiary of the EU’s Recovery and Resilience Fund (RRF); only Italy has received more. The RRF provides loans and grants to EU member states for reforms and investments to make economies greener, more digital and ultimately more resilient. Spain received over €20 billion as recently as August for investment in renewable energy, rail and cybersecurity. The push into renewable energy because of the funds received from the RRF has reduced energy cost pressure and increased industrial competitiveness.

A final reason why the Spanish economy has performed so well has been the resiliency of tourism. Tourism accounts for approximately 12% of Spain’s GDP. Spain had a record number of visitors in 2024, an increase of 10% compared to 2023, and that record is expected to be beaten once again in 2025.

Combining the strength of the economy, investments and improved credit rating leads to the Spanish stock market outperforming. The outperformance is also helped by the composition of the IBEX 35, which has a large exposure to banks and financial institutions. The banks have outperformed on the back of the strong macroeconomic backdrop and improved asset quality post structural reforms. Spanish banks have low US tariff exposure, as do other domestic focused industries such as utilities and telecommunication companies.

Global Alpha counts three Spanish companies in its portfolios that give exposure to Spanish tourism, the resilient labour environment and domestic spending. Meliá Hotels International S.A. (MEL ES) owns and manages hotels and resorts. Meliá operates luxury, upscale and mid-scale hotels and resorts. Meliá operates hotels in Europe, Asia and the Americas. With fiscal spending increasing in Europe, consumer sentiment should improve, and leisure spending continues to show resilience. The demand in Spain means rates should remain strong and Meliá is well placed to benefit. Meliá has a much-improved balance sheet that trades at an attractive valuation.

Fluidra S.A. (FDR SM) is a global leader in the pool and wellness industry. They design and manufacture a range of products for residential and commercial swimming pools. The products include pumps, valves, heaters, filters, pool-cleaner robots, chemicals, and devices for pool IoT devices. Around 70% of Fluidra’s sales are to the residential end-market, and aftermarket accounts for the majority of Fluidra’s sales over the cycle, providing resilience while the industry waits for new-build activity to recover. Fluidra continues to trade at a discount to its US peers.

Merlin Properties Socimi S.A. (MRL SM) is the largest Spanish commercial REIT. It operates a 100% Iberian portfolio centred around offices, shopping centres, logistics, and most recently, data centres. Most of its assets are in the prime cities of Madrid, Barcelona, and Lisbon. The recent investment in data centres will start to contribute meaningfully to rental income by 2028 and represents the next leg of growth.

A headwind for Spain’s continued prosperity is that the minority government has been unable to pass much legislation. It has, however, avoided much of the turmoil seen in France. The challenge now is to capitalize on the domestic demand, robust tourism and EU recovery funds to continue to outperform its European peers.