Mark Barnes, PhD,
Indhu Raghavan, CFA,
- While the US equity rally since 2022 has been dominated by eye-popping returns from large-cap Tech, performance patterns over Q2 and Q3 may reflect the resurgence of other industries and sectors as return drivers.
- During Q2/Q3, large-cap industries besides Tech rallied broadly, and most small-cap Russell 2000 industries rallied further, outperforming their Russell 1000 counterparts.
- Investment themes such as gold, aerospace and defense, and AI spin-offs may represent new pockets of outperformance in a market that has been dominated by large Tech returns.
It may seem like decades ago, but ChatGPT was released to the public on November 30, 2022, a little less than three years ago. The stock market was in the midst of the first major post-Covid sell-off that left the Russell 1000 down 24.6% for the first three quarters of 2022, and the Tech industry down 35.1%. The equity market rally since then has been characterized by the centrality of Tech and specifically large-cap Tech associated with AI. However, performance patterns over Q2 and Q3 of 2025 show some interesting variations, possibly reflecting the resurgence of other industries and sectors as return drivers.
Exhibit 1 illustrates the dominance of large-cap Tech during this rally since September 2022. The Russell 1000 returned an annualized 24.6% over this three-year period, driven by the Russell 1000 Tech industry’s 42.1%. Looking at the rest of the US equity market, we see that during that time period, the Russell 2000 had an annualized return of 15.2% and the other Russell 1000 industries (ex-Tech) had a similar return of 15.3% on average. Although an annual 15% return over three years is quite respectable by historical standards, these non-tech segments of the market have faded to the background given the focus on AI capital investment and its impact. pact.
Exhibit 1. Cumulative total returns (USD, 9/30/2022=100)
Source: FTSE Russell/LSEG. Data as of 30 September 2025. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Q2/Q3 2025: greater breadth in the equity rally
2025 has seen some new sources of market volatility, many related to policy uncertainty. The announcements of steep US tariffs on April 2nd led to a market plunge quickly followed by a recovery as many of those tariffs were put on hold. This rebound extended through the second and third quarters as Q1 pessimism gave way to continued economic growth and robust corporate earnings. However, we noticed that there has been a broadening of market performance into the small-cap Russell 2000 universe, and away from the Tech industry to other pockets of the market. Part of this broadening is due to the Russell 2000’s more diversified industry composition -- as the smaller caps do better in general, it shows up in more industries. But we also see that within both large caps and small caps there are new pockets of outperformance driven by evolving investment themes.
Exhibit 2 shows the Russell 1000 and Russell 2000 industry returns for the combined Q2/Q3 period. During this 6-month period, the Russell 2000 slightly outperformed the Russell 1000 with a return of 21.9% to 20.0%, as shown by the dotted lines. More interesting is the distribution of returns across industries. In the Russell 1000, the Tech industry significantly outperformed the Russell 1000 index with a return of 41.6% (very close to its three-year average of 42.1%), and the Consumer Discretionary industry just slightly outperformed with 20.3%. However, all the other industries underperformed, with three of the industries posting losses. Again, the large-cap performance pattern was dominated by Tech.
However, within the small-cap Russell 2000, four of the eleven industries outperformed the index by a wide margin, five others had returns above 10%, and all of the industries were positive. It is interesting that even in Technology, the Russell 2000 slightly outperformed the Russell 1000 (41.7% to 41.6%). It seems that this broadening away from large-cap Technology is best seen in the small-cap space, where more Russell 2000 industries beat their benchmark and most outperformed their large-cap counterparts in this period.
Exhibit 2: Russell 1000 and Russell 2000 industry returns, Q2/Q3 2025
Source: FTSE Russell/LSEG. Data as of 30 September 2025. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Pockets of outperformance
When we look at the pockets of the market that have done particularly well, a few investment themes emerge. Exhibits 3 and 4 show the ten sectors[Note1] with the highest returns over the Q2/Q3 2025 period for both the Russell 1000 and Russell 2000. A comparison shows that there are interesting similarities across the size spectrum. The themes that jump out are:
- Gold
- Aerospace and Defense
- AI spin-offs
The first theme that emerges is that the run-up in gold (44.5% annualized over the last two years) has created investor enthusiasm for all things gold-related. The top performing sector in both the large-cap and small-cap universes is Precious Metals and Mining (and one of the top 5 best performing subsectors is Gold Mining), although the return is more than twice as high in the small caps (notice that the scales on the charts are different). Gold has enjoyed several secular tailwinds recently with central bank demand for reserve diversification, particularly from emerging markets, as an inflation hedge under certain monetary regimes, and as a safe haven asset in uncertain times.[Note2]
Exhibit 3: Russell 1000: Q2/Q3 top 10 sectors, with comparison to benchmark
Source: FTSE Russell/LSEG. Data as of 30 September 2025. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Exhibit 4: Russell 2000: Q2/Q3 top 10 sectors, with comparison to benchmark
Source: FTSE Russell/LSEG. Data as of 30 September 2025. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
The second sector theme is Aerospace and Defense. Amid ongoing geopolitical conflicts, European governments have explicitly identified becoming less reliant on US military support as a strategic priority. To this end, Germany set defense spending targets earlier in 2025 that are likely to benefit the US defense industry alongside European defense stocks. In fact, as part of the US-Europe trade agreement entered in July 2025, Europe has agreed to purchase a certain amount of US defense equipment.[Note3]
Lastly, we look at AI spin-offs, or companies that support the AI boom and benefit from the heavy capital investment in this space rather than participate directly in the development and use of Generative AI. While large-cap Tech is still well represented in Exhibit 3, with both tech hardware and software making an appearance, we also see performance in related sectors, primarily those providing supporting hardware (Technology Hardware and Equipment and Telecommunications Equipment), building data centers (Construction and Materials[Note4]), and providing electricity to data centers (Alternative Energy and Electricity).
It is also interesting to note that, of the top ten sectors, six of them are common across the two size universes, as shown in Exhibit 5. In each case, the small-cap sector had a higher return during Q2/Q3, underscoring the broadening of the equity rally.
Exhibit 5: Common Russell 1000 and Russell 2000 sectors in the top 10 for Q2/Q3 returns
Source: FTSE Russell/LSEG. Data as of 30 September 2025. Past performance is no guarantee of future results. Please see the end for important legal disclosures.
Conclusion
For the last three years, US equity market returns have been dominated by the AI theme. This focused investor attention, returns, and capitalization growth in large-cap Tech sectors. However, in Q2/Q3 2025, we saw the large-cap Tech dominance moderating, and other industries and smaller companies participating in the rally. In fact, many small-cap industries and sectors outpaced their large-cap counterparts over this 6-month period, a sign of the broadening equity rally and the role of other secular investment themes in play. While many of the benefiting sectors were still related to the AI euphoria, they tend to play supporting roles rather than be directly involved in developing AI technology. Finally, we also saw pockets of outperformance in gold and defense related stocks, perhaps partly reflecting the current geopolitical uncertainty.
Footnotes
[1] The 11 industries are broken into 44 sectors and 172 subsectors. | Back to Note 1
[2] For a detailed discussion of historical and recent drivers of gold prices, see “Gold in a fragmented world: Safe haven and strategic asset.” | Back to Note 2
[3] Fact Sheet: The United States and European Union Reach Massive Trade Deal – The White House | Bank of England | Back to Note 3
[4] There are other drivers, notably a structural deficit in residential housing that has supported builders’ profitability, and recent public investment or incentives for non-residential construction through the CHIPS and Science Act, Infrastructure Investment and Jobs Act, and Inflation Reduction Act. | Back to Note 4
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