US equity markets climbed higher in the second quarter, outperforming non-US developed and emerging markets. With investor appetite gravitating toward domestically oriented companies, smaller-cap stocks outperformed mid and large caps. Value names outperformed in small cap, but growth stocks beat in mid and large. Core bonds were slightly negative while convertibles posted healthy positive returns, driven by their shorter duration and the increase in option value as small/mid-cap companies, which dominate issuance, outperformed. The TR All Cap Focus Convertibles Index returned 3.5% for the quarter and is up 5.9% versus 2.7% and -1.6% for the S&P 500 and Barclays Aggregate, respectively, for the year to date.
Our equities and convertibles strategies all generated positive absolute returns for the quarter, with Healthcare Opportunities, US Equity Opportunities, US SMID Cap Growth and US Small Cap up especially strongly on the outperformance of smaller-cap names and M&A activity in healthcare. All strategy composites outperformed their primary benchmarks, gross of fees. (See Performance Summary, page 2 of the PDF).
We believe that although US economic growth and US company earnings remain strong, potential downside risk is building due to geopolitical tensions, less open trade policies as well as the unwinding of low interest rate policies. Global growth trends became less synchronized in 2Q, suggesting soft patches. Yet near-term consensus earnings estimates in the US remain strong with 20% EPS growth forecasted in 2Q for the S&P 500 Index, according to FactSet. Small-cap earnings for 2Q are forecasted to be even stronger than large, the first time since 2Q16.
We are treading carefully. Revenue and earnings growth may indeed prove to be very strong this reporting season, and yet the potential for greater risk to growth in 2019 and 2020 is a cause of concern. Our style of investing in dynamically growing companies is susceptible to multiple compression as earnings visibility becomes cloudier, so we are prudently selling names that we believe have reached their fair value or trade above their historical averages. We remain vigilant in selecting those companies that have secular growth drivers and high-quality management teams able to execute through a changing business climate, and where we have high visibility and confidence in future earnings. We believe that the combination of equity and credit research we do provides differentiated insights that benefit our portfolios, especially regarding assessing potential risks.