US Small-Caps Take “The Pause That Refreshes”

US small-cap leadership remains attractive because earnings, balance-sheet strength, and long historical cycles outweigh the near-term pressure from higher rates.

• In 3Q26, the Russell 2000 Value Index fell 4.9% and the Russell 2000 Growth Index fell 9.4%, while from April 8, 2025 through September 30, 2026 they returned 63.4% and 60.5%, respectively.
• The quarter was dominated by mega-cap technology, including Apple, Meta, Microsoft, Advanced Micro Devices, Micron Technology, and Nvidia; hyperscaler capital expenditure for 2026 was estimated at $700-$775 billion, but smaller AI-related companies had not yet attracted comparable investment.
• Small-cap fundamentals remained resilient in 3Q26: Russell 2000 sales per share rose 2.9%, free cash flow per share increased 11.2%, and EPS climbed 19.5%, versus 6.6% and 10.2% growth in free cash flow per share and EPS for the Russell 1000.
• The authors' review of previous Fed tightening cycles found little evidence that higher rates caused persistently weaker small-cap returns; earnings were a more reliable guide, while higher rates mainly threaten the most expensive stocks through their multiples.
• Their nearly century-long CRSP comparison identified eight completed leadership cycles before the current one, with four led by each asset class; the shortest lasted five years and the three longest lasted 14 to 16 years.

Takeaway: Investors with a long horizon should use small-cap pullbacks to build active positions in profitable, financially strong companies, while recognizing that the thesis depends on earnings growth and does not eliminate short-term rate and macroeconomic risks.