Russell 2000 nears correction, down ~9% from August peak. What should investors do?

U.S. small caps have lost their year-to-date lead over large caps as the Russell 2000 has fallen almost 9% from its August all-time high and is now approaching correction territory. Rising borrowing costs are weighing on smaller companies, which are more sensitive to high interest rates. Oninvest analyst Aldiyar Anuarbekov examines what could revive interest in the segment and offers two stocks merit attention after the selloff.

As recently as this summer, 2026 looked set to be a comeback year for small caps. At the end of June, the Russell 2000 was up more than 21% year to date, while the S&P 500 had gained just 7.4%, putting the performance gap between the indexes at its widest for the year. On August 14, the Russell 2000 set a record closing high of 3,068.42 points. Yet by early October, its outperformance had evaporated: as of Friday, October 9, the S&P 500 had gained 14% year to date, overtaking the small-cap index, which was up 13%.

The Russell 2000 is now trading 8.9% below its August record and approaching a correction, defined as a 10% decline from a peak. The index has yet to enter correction territory: that would require a close at or below 2,761.58 points.

One of the main sources of pressure is higher-cost borrowing. In September, the Fed raised its benchmark rate to 3.75-4.00%, and most meeting participants consider another hike before year end likely, according to the minutes from the last FOMC meeting. The 10-year U.S. Treasury yield reached 5.35% on October 8, its highest level since 2002.

This is particularly painful for smaller companies, which typically carry more debt and have a higher proportion of floating-rate borrowing, Truist Advisory Services CIO Keith Lerner explains.

The index’s decline does not tell the whole story. According to Bloomberg Intelligence data (the note was seen by Oninvest), the median Russell 2000 stock is trading around a quarter below its 52-week high. In other words, individual stocks within the index have suffered much deeper declines than the Russell 2000 itself.

UBS estimates show that relative to expected earnings, small caps are now cheaper than in around 75% of historical observations. The reverse is true for large caps: their valuations are higher than in 75% of observations. This suggests smaller companies are relatively cheap, although that alone does not guarantee the stocks will go up.

The next test for small caps is third-quarter earnings. The results will show whether companies can sustain profits despite costlier financing and whether there is reason to expect earnings growth.

Lower interest rates, however, are not a prerequisite for small caps to regain their lead. Royce Investment Partners co-CIO Francis Gannon notes that small caps outperformed large caps on average during previous rate-hiking cycles. The only exception was the most recent cycle, when the Fed began raising rates in March 2022 and brought them to 5.25-5.50% by July 2023, while the largest tech companies accounted for most of the market’s gains. In his view, the direction of interest rates is an unreliable predictor of which group of stocks will lead. Earnings and business quality matter more for long-term returns, Gannon says.

Oninvest examined 357 industrial and real estate companies held by the iShares Russell 2000 ETF (IWM), which tracks the Russell 2000. These two sectors are seeing the strongest improvements in revenue forecasts, according to Bloomberg Intelligence data.

We looked for profitable firms with positive free cash flow, moderate debt, and operating income exceeding interest expense by more than two times. An additional requirement was a stock decline of more than 25% from its 52-week high. Twenty-three companies passed the screen. We then excluded those whose stock declines were tied to problems with the business itself and a high sensitivity to elevated interest rates, selecting one company from each sector: filter maker Atmus Filtration and real estate investment trust National Health Investors.

Atmus Filtration (ATMU)

Atmus Filtration makes filters for trucks and industrial equipment. Following its acquisition of Koch Filter, the company expanded into air filtration, including for data centers and power plants.

In the second quarter, revenue rose 16.4% year over year to a record $528 million, adjusted free cash flow increased to $67 million from $36 million, and the management raised its full-year guidance. Atmus CEO Stephanie Disher said a cyclical recovery in demand for filters used in new trucks began toward the end of the quarter. BofA analysts also wrote in a note (seen by Oninvest) that they expect increased shipments for new trucks and improving margins.

The main risk is debt following the Koch Filter acquisition. At the end of June, it stood at almost $1 billion. Second-quarter operating income covered interest expense around seven times, but floating-rate borrowings leave the company sensitive to high financing costs.

As of Monday, Atmus stock traded at $43.09 per share, almost 35% below its 52-week high. On August 10, BofA reiterated its “buy” recommendation at a target price of $73 per share, 69% above Monday’s closing price. On September 23, Northland maintained its “outperform” rating at a target price of $67 per share.

According to MarketWatch data, the stock has five “buy” calls from Wall Street analysts versus one “hold” rating. The average target price of $62.60 per share implies 45% upside from the last close.

National Health Investors (NHI)

NHI owns senior housing and medical facilities. The company is expanding the part of its business in which it collects resident payments and bears property operating expenses, while specialist operators handle day-to-day management. This allows it to participate in revenue growth at the properties, but also increases its exposure to operating costs and management quality.

The long-term investment case rests on demographics. A forecast from analytics firm NIC MAP indicates that the number of Americans age 80 and older will grow by around a third by 2030. New housing construction is lagging demand: in the second quarter, occupancy in markets tracked by NIC MAP approached 90%.

Nevertheless, same-property net operating income in this segment fell 6.3% in the second quarter, while normalized funds from operations per share, a measure used to assess REIT performance, declined 2.5%.

Meanwhile, as of June 30, net debt stood at 4.1 times annual EBITDA, within the company’s target range, and operating income covers interest expense around four times. NHI increased its quarterly dividend to $0.94 per share. At Monday’s price of $65.62 per share, that translates into an annual dividend yield of around 5.7%, assuming the payout remains unchanged. The stock is trading around 28% below its 52-week high.

The risk lies in how successfully the company expands its business and deploys the proceeds from the $560 million sale of part of its portfolio. Debt levels and financing costs also remain important for NHI.

On August 14, Cantor Fitzgerald reiterated its recommendation to buy the REIT’s stock at a target price of $90 per share, implying 37% upside from the current price. In September, a Truist analyst lowered their target price to $80 from $81 per share while maintaining a “buy” rating.

NHI stock has lost around 14% year to date. According to MarketWatch data, it has six “buy” ratings versus three “hold” calls. The average target price of $80.70 per share implies 23% upside from Monday’s close.

This text is for informational purposes only and does not constitute personalized investment advice.