The third quarter of 2026 presented a paradoxical picture for equity markets. While the Morningstar US Market Index closed the period at a modest 1.7% gain, its year-to-date return climbed to 12.6%, and the Morningstar Global Markets ex-US Index added 0.7% to reach a 13.9% YTD increase. Behind those headline numbers, geopolitical friction multi-decade highs in U.S. Treasury yields and growing concerns over artificial intelligence safety created a volatile backdrop that split stock-fund performance into winners and losers.
Tech titans stumble as the AI rally cools
Technology remained one of the year’s top-performing categories, but the engine that powered the first half—an aggressive AI infrastructure push—lost momentum in July and August. Semiconductor exposure, which had delivered triple-digit gains earlier, slipped 4% in the Morningstar US Semiconductor Index. Meanwhile, software stocks, previously hammered as AI “losers,” staged a striking comeback, with the Morningstar US Software Capped Index rallying 25% before a modest 2% pullback in September. This intra-sector swing rewarded managers who shifted toward software and penalised those still heavily weighted in hardware.
Active funds that embraced the software rebound shone. Oakmark Select (OAKLX) posted a 12% quarterly gain, buoyed by substantial jumps in Salesforce (CRM) (+47%) and Paycom (PAYC) (+73%). Mid-cap value player Hotchkis & Wiley Opportunities (HWAAX) rose 5% after Workday (WDAY) and Microsoft (MSFT) recovered from earlier dips. Even a small-cap specialist, Brown Capital Management Small Company (BCSIX) managed a 9% increase despite its peers averaging a 10% loss, thanks to heavy positions in Veeva Systems (VEEV) and Manhattan Associates (MANH).
Conversely, thematic vehicles with concentrated exposure to AI hardware suffered. The Tortoise AI Infrastructure ETF (TCAI)—one of the year’s top performers with a YTD gain of 58%—ended the quarter down 16% as semiconductor and equipment stocks faltered. Peer funds such as iShares A.I. Innovation (BAI) and AB Disruptors (FWD) each posted double-digit declines, underscoring the risk of overconcentration in a single megatrend.
Small-caps lose ground while large-caps stay steady
Rising interest rates proved more punitive for the small-cap segment. All U.S. large-cap categories managed modest positive returns, yet small-cap groups slipped between 5% and 10% during the quarter. The attrition was especially sharp in small-growth funds, which fell roughly 10% as high-momentum AI-related names retraced their steep April-June climbs. Notable laggards included Lord Abbett Developing Growth (LAGWX) (-17%), Invesco Small Cap Growth (GTSAX) (-16%) and AB Small Cap Growth (QUASX) (-14%). Their shared focus on earnings momentum and price acceleration left them exposed when the tech rally waned.
Meanwhile, sectors outside the AI frenzy delivered solid performance. Energy funds benefited from geopolitically driven oil price spikes, delivering an average 6% rise; Fidelity Advisor Energy (FFOBX) surged 15% alone. Healthcare funds logged a 4% sector gain, highlighted by Fidelity Select Health Care (FSPHX) up 9%. International value funds also fared well, with foreign small/mid-value funds gaining 6%—driven by holdings such as European recruiter Hays (HAS) (doubling) and Australian medical-device maker Ansell (ANN) (+43%).
Emerging markets and correction risk temper optimism
Beyond the United States, emerging-market equities reverted to a more subdued rhythm. The Morningstar Developed Markets ex-US Index edged up 1.3%, while the Emerging Markets Index fell 0.8%. Funds focused on Asia-Pacific faced a 12% drop, with top holdings like Taiwan Semiconductor Manufacturing (TSM)Samsung Electronics (005930) and SK Hynix (000660) all weakening. The broader market’s resilience was tested when the S&P 500, after hitting an all-time high in mid-August, slipped 1.5% from that peak, though it remained 22% above its March low.
Analysts caution that a correction—defined as a 10% fall from recent highs—remains plausible. Drivers could include persistent inflation, tighter Federal Reserve policy, renewed energy disruptions, or a sudden credit crunch. Nevertheless, strong corporate earnings (16% revenue growth and a 53% earnings jump YoY in Q2) and robust business investment in AI infrastructure provide a cushion. The broad participation across nine of eleven S&P sectors, plus gains in mid-cap and small-cap stocks, suggests that, for now, the rally is supported by fundamentals rather than a narrow set of tech leaders.
A slowdown in the AI-driven surge, coupled with climbing Treasury yields, stripped momentum from small-caps and theme-specific ETFs, while diversified large-cap, energy, healthcare and foreign-value funds captured the upside. Investors should watch the interplay of earnings strength, rate trajectories, and geopolitical cues to gauge whether the market will sustain its gains or slide into a correction.
