Navigating Factor Divergence: Strategic Rotation in a Regime-Shifting Market

The S&P 500 factor landscape in 2025 has become a battleground of divergent performances, with Momentum, Value, and Quality indices exhibiting starkly different trajectories. As investors grapple with the dual forces of AI-driven euphoria and macroeconomic uncertainty, the case for regime-aware factor rotation has never been more compelling. Historical data and 2025's real-time dynamics suggest that tactical shifts toward undervalued, historically resilient factors-particularly U.S. Value and international Quality-could enhance risk-adjusted returns in an increasingly volatile market.

2025's Factor Divergence: Momentum's Dominance and Value's Resurgence

The year-to-date performance of S&P 500 factor indices as of November 2025 reveals a striking divergence. The Momentum factor has surged with a 12.4% excess return, driven by AI-centric stocks like Tesla and a broad rally in consumer cyclical and financial services sectors as of November 2025. This outperformance mirrors patterns from the late 1990s, suggesting a continuation of speculative fervor as research shows.

Meanwhile, the Value factor has staged an unexpected comeback. The S&P 500 Pure Value Index outperformed the S&P 500 by 4.3% in August 2025, improving its year-to-date relative performance to -0.6% according to Q3 2025 data. This reversal is attributed to favorable intrasector stock exposure in healthcare, financial services, and consumer defensive sectors, with names like JPMorgan Chase and Altria playing pivotal roles as per Morningstar's Q3 2025 analysis. The simultaneous strength of Momentum and Value-typically negatively correlated-highlights a rare market regime shift as reported by Morningstar.

The Quality factor, represented by the Invesco S&P 500 Quality ETF (SPHQ), has delivered a 14.24% YTD return as of December 12, 2025 according to Yahoo Finance. This performance underscores the resilience of high-quality stocks, even as growth-oriented Momentum dominates.

Historical Regime Cycles: Lessons for Strategic Rotation

Historical data from 1980 to 2025 reveals distinct factor behaviors across bull and bear markets. During secular bull markets, such as the 1982–2000 period, the S&P 500 achieved an annualized return of 16.6%. In these environments, Momentum and Growth factors typically thrive, while Value and Quality often lag. Conversely, bear markets-such as the 2007–2009 crisis-see Quality outperform by margins of 4% annually, thanks to its focus on profitability and low volatility as soundmind investing reports.

The 2025 data aligns with these historical patterns. The S&P 500 Momentum Index's 12.4% YTD excess return reflects its bull-market strength as per Q3 2025 analysis, while the S&P 500 Pure Value Index's August outperformance signals a potential shift toward value strategies as growth multiples normalize as data shows. Meanwhile, the Quality factor's 14.24% YTD return suggests it is already acting as a defensive anchor, a role it historically assumes in bear markets as reported by Yahoo Finance.

AI-Driven Euphoria and the Case for Rotation

The current market environment is shaped by AI-driven optimism, which has inflated valuations for high-growth, low-earnings stocks. This speculative phase mirrors the dot-com bubble, where Momentum and Growth factors peaked before a sharp correction. As of Q3 2025, the S&P 500 Momentum Index's performance-led by Tesla and other AI beneficiaries-indicates a market still in the euphoric phase as per Morningstar's Q3 2025 report. However, historical cycles suggest this phase is unsustainable without earnings growth to justify valuations.

Conversely, U.S. Value and international Quality factors are undervalued relative to their historical resilience. The MSCI USA Enhanced Value Index, for instance, is sector-neutralized and has outperformed other value indexes in 2025 as of Q3 2025, signaling a potential inflection point for value strategies. Internationally, the iShares MSCI International Quality Factor ETF (IQLT) has delivered a 23.83% YTD return according to Yahoo Finance, demonstrating that quality stocks in developed markets can thrive even in a growth-dominated environment.

Actionable Recommendations: Balancing Growth and Resilience

To capitalize on 2025's factor divergence, investors should adopt a regime-aware allocation:
1. Overweight U.S. Value: The S&P 500 Pure Value Index's August outperformance and its historical tendency to rebound in bear markets make it a compelling candidate for tactical exposure as of Q3 2025.
2. Underweight Momentum: While Momentum remains dominant, its reliance on speculative AI-driven stocks increases downside risk as earnings expectations normalize as per Morningstar's analysis.
3. Enhance Exposure to International Quality: The IQLT's 23.83% YTD return and GMO's finding that quality stocks outperform by 4% annually in bear markets as reported by soundmind investing justify a strategic tilt toward this factor.
4. Consider Multi-Factor Indices: The S&P 500 Quality, Value & Momentum Multi-Factor Index, which combines 100 stocks across these factors, offers a balanced approach to diversification as detailed by S&P Global.

Conclusion

The 2025 factor landscape underscores the importance of regime-aware investing. As Momentum and Value coexist in an unusual alignment, and Quality demonstrates its defensive prowess, investors must move beyond static allocations. By leveraging historical insights and current data, a tactical shift toward undervalued, historically resilient factors can mitigate risk while capturing growth in a shifting market.