Robert Bush
Carter Johnson
The broadening of US equity market performance, and the lower P/Es in the third quarter.
Key Takeaways
- Large caps and value regained leadership in Q3. Higher bond yields and tighter financial conditions favoured larger companies and value-oriented sectors, while weighing on small caps and growth stocks.
- Small-cap participation has weakened but remains intact. Despite underperforming in Q3, small caps continue to lead large caps over longer time periods, suggesting market broadening has slowed rather than reversed.
- Valuations have reset to healthier levels. Higher rates compressed valuation multiples across the market, but resilient earnings growth helped support equity prices and kept valuations near historical norms.
We recently released our third quarter Russell US Indexes Spotlight, and noted several interesting developments in the US equity space. Firstly, the third quarter marked an important shift in market leadership, with large-cap stocks regaining the advantage over small-caps after several quarters of broadening market participation. While the Russell 2000 had outperformed during the second quarter, the Russell 1000 returned 1.8% in Q3 compared with a decline of 7.2% for the Russell 2000, highlighting the challenges faced by smaller companies as financial conditions tightened, and bond yields moved higher. Despite this setback, small-caps continued to maintain an advantage over longer horizons, with the Russell 2000 delivering 16.2% over the previous 12 months, versus 15.0% for the Russell 1000.
Secondly, style leadership also favoured Value over Growth across both market-cap segments. Within large-caps, the Russell 1000 Value Index gained 2.6% during the quarter, comfortably ahead of the 0.9% return generated by the Russell 1000 Growth Index. The pattern was even more pronounced among small-caps, where the Russell 2000 Value Index declined 4.9%, outperforming the Russell 2000 Growth Index, which fell 9.4%.
We believe that much of this performance dispersion can be attributed to the higher-rate environment in the third quarter. For much of this year we have witnessed rising Treasury yields, and our view is that these naturally act as a headwind for longer-duration growth assets and rate-sensitive small-caps, while sectors more heavily represented within value indices benefited from stronger commodity prices and resilient economic activity. Energy-related companies were among the strongest performers during the quarter, supported by higher oil prices, while Precious Metals and Mining also contributed positively.
Chart One illustrates these two key themes currently shaping US equity markets, but which are playing out over different timeframes: in the short run, a renewed preference for large-cap companies, and continued value outperformance. But, in contrast to that, longer-term data which shows that small-cap equities remain competitive on both a year-to-date and trailing 12-month basis - suggesting that broadening market participation has slowed rather than disappeared. Investors therefore continue to balance the defensive appeal of larger, more profitable businesses against the potential earnings recovery still expected within segments of the small-cap universe.
Chart One: A volatile third quarter, but longer run equity broadening
Source: FTSE Russell and LSEG. Data as of September 2026. Past performance is not a guide to future returns. Please see the end for important legal disclosures.
| Russell US index | 3M (%) | YTD (%) | 12M (%) |
|---|---|---|---|
| Russell 1000 | 1.8 | 12.3 | 15.0 |
| Russell 1000 Growth | 0.9 | 6.3 | 7.5 |
| Russell 1000 Value | 2.6 | 19.3 | 23.8 |
| Russell 2000 | -7.2 | 13.7 | 16.2 |
| Russell 2000 Growth | -9.4 | 10.7 | 12.1 |
| Russell 2000 Value | -4.9 | 17.0 | 20.8 |
| Russell Top 200 | 3.0 | 12.3 | 15.7 |
| Russell Midcap | -3.0 | 11.8 | 12.0 |
Building on the performance trends discussed above, valuations became a more important driver of returns during the third quarter as higher bond yields and a more hawkish policy backdrop led investors to reassess the price they were willing to pay for future earnings. While earnings expectations remained broadly resilient, particularly in growth-oriented sectors, multiples moved lower across almost every major Russell segment.
Chart Two highlights the broad-based valuation de-rating across both large and small-cap equities. Twelve-month forward P/E ratios declined across nearly all Russell 1000 and Russell 2000 style indexes during Q3, with most segments ending the quarter below their levels of a year earlier. Despite these declines, a sizeable valuation premium remains attached to growth stocks, particularly within the small-cap universe, reflecting investors' continued willingness to pay for stronger expected earnings growth and exposure to structural themes such as artificial intelligence.
At first glance, the combination of falling valuations and generally positive equity returns may appear contradictory. However, the market's performance over recent quarters has increasingly been supported by rising earnings expectations rather than multiple expansion. As Treasury yields pushed to multi-decade highs and the Federal Reserve maintained a restrictive stance, higher discount rates created a natural headwind for equity valuations. The result was that earnings growth continued to support share prices, but investors became less willing to extend valuation multiples further.
Chart Two: Less expensive, but hardly cheap…
Source: FTSE Russell and LSEG. Data as of September 2026. Past performance is not a guide to future returns. Please see the end for important legal disclosures.
| Russell US index | Sep 2026 | 3 months ago | 1 year ago | 5-year average |
|---|---|---|---|---|
| Russell 1000 | ~19.2 | ~19.9 | ~22.7 | ~20.0 |
| Russell 1000 Growth | ~21.8 | ~24.2 | ~30.8 | ~26.2 |
| Russell 1000 Value | ~17.4 | ~16.9 | ~17.7 | ~16.0 |
| Russell 2000 | ~23.7 | ~26.7 | ~26.1 | ~23.9 |
| Russell 2000 Growth | ~39.5 | ~35.9 | ~37.1 | ~35.1 |
| Russell 2000 Value | ~17.0 | ~20.7 | ~19.7 | ~18.0 |
| Russell Top 200 | ~20.0 | ~20.6 | ~24.1 | ~20.7 |
| Russell Midcap | ~16.9 | ~17.8 | ~18.6 | ~17.8 |
This dynamic was particularly visible within large-cap growth stocks. Although many technology companies continued to deliver strong earnings momentum, valuations moderated as investors demanded greater compensation for duration risk in a higher-rate environment. Interestingly, this pattern was less evident within small-cap growth equities, where valuation compression was more pronounced in value segments, highlighting the differing composition and economic sensitivities of the two universes.
From an investor perspective, the valuation reset may ultimately prove constructive. Current multiples remain broadly consistent with longer-term averages rather than indicating a broad market dislocation. For investors who have become concerned about stretched valuations following several years of strong market gains, recent pullbacks provide evidence that excess optimism has begun to unwind. Importantly, this adjustment has occurred primarily through stronger earnings growth and modest multiple compression rather than through a severe decline in equity prices. As a result, the market enters the final quarter of the year with valuations that appear healthier, while still retaining support from a relatively resilient earnings outlook.
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