Dodge & Cox Stock Fund commentary for the second quarter ended June 30, 2016.

H/T Dataroma

The Dodge & Cox Stock Fund had a total return of 1.7% for the second quarter of 2016, compared to 2.5% for the S&P 500 Index. For the six months ended June 30, 2016, the Fund had a total return of 0.7%, compared to 3.9% for the S&P 500.

Dodge & Cox Stock Fund

Dodge & Cox Stock Fund – Market Commentary

The U.S. equity market was one of the best performing developed markets in U.S. dollars during the second quarter, although macroeconomic and geopolitical issues continued to create meaningful volatility. In June, the S&P 500 approached its all-time high, then retreated after the United Kingdom’s vote to leave the European Union (“Brexit”) triggered a “flight to safety.” Global equity markets declined sharply, safe-haven bonds rallied, and the U.S. dollar strengthened significantly against several major currencies, especially the British pound. The S&P 500 subsequently rebounded to end the quarter up 2.5%.

The Federal Reserve left short-term interest rates unchanged, and the future path and pace of increases remains uncertain given global economic and financial developments and somewhat weaker U.S. economic data. While the U.S. economy showed some signs of improvement (e.g., 4.7% unemployment rate, a rebounding housing market), other areas showed softness (e.g., manufacturing data, durable goods orders, a lackluster May jobs report).

For the quarter, Energy (up 12%) was the strongest sector in the S&P 500 as Brent crude prices temporarily climbed above $50 per barrel for the first time since November 2015. As a result of “risk-off” market sentiment, the more defensive sectors—Utilities and Consumer Staples—also appreciated notably; companies in these sectors are now priced at a premium to their more cyclical counterparts (e.g., Financials). As of June 30, the Fund had no holdings in the Utilities sector and was significantly underweight the Consumer Staples sector.

We believe recent market conditions have created long-term investment opportunities in more economically sensitive companies. Using our bottom-up research framework, we revisited and retested our thinking on many of the Fund’s holdings and recently added to selected companies, including several in the Financials sector (e.g., American Express, Bank of America, Goldman Sachs, MetLife). Facing the challenges of a potentially weaker global economy and low interest rates, the Fund’s bank holdings trade at inexpensive valuations. However, many of these companies have improved earnings and have capital ratios that are meaningfully higher than they were prior to the global financial crisis. Interest rates are trading at historically low levels, and if they were to rise (or simply stop falling), that would increase profitability within the sector, further benefiting banks.

While many investors focus on current market volatility, it is important to recognize there is always uncertainty when investing. Our experience through similar and even more volatile periods in the past reminds us that the best investment opportunities often arise in periods of uncertainty and trepidation. We can capitalize on these opportunities because our bottom-up research process and multi-year time horizon provide the fortitude to stay with our convictions, even in periods of volatility or portfolio underperformance.

Overall, we believe the Fund is well positioned and remain optimistic about the long-term outlook for the portfolio. Patience, persistence, and a long-term investment horizon are essential to long-term investment success. We encourage our shareholders to take a similar view of investing.

Dodge & Cox Stock Fund

Second Quarter Performance Review

The Fund underperformed the S&P 500 by 0.8 percentage points for the quarter.

Key Detractors From Relative Results

  • Returns from holdings in the Financials sector (down 3% compared to up 2% for the S&P 500 sector), combined with a higher average weighting (26% versus 16%), significantly detracted from results. AEGON (down 25%), Charles Schwab (down 9%), Capital One (down 8%), and Goldman Sachs (down 5%) performed poorly.
  • While contributing to absolute performance, the Fund’s holdings in the Energy sector (up 8% compared to up 12% for the S&P 500 sector) hurt relative returns. Weatherford International (down 29%) was weak.
  • Additional detractors included Cigna (down 7%) and FedEx (down 6%).

Key Contributors To Relative Results

  • Returns from holdings in the Information Technology sector (flat compared to down 3% for the S&P 500 sector) contributed to relative results, especially Symantec (up 12%).
  • The Fund’s holdings in the Health Care sector (up 7% compared to up 6% for the S&P 500 sector) aided performance. Novartis (up 14%), Roche (up 8%), and Sanofi (up 7%) were strong.
  • Additional contributors included Sprint (up 30%), Tyco International (up 17%), and Apache (up 15%).

Dodge & Cox Stock Fund

Year-To-Date Performance Review

The Fund underperformed the S&P 500 by 3.2 percentage points year to date.

Key Detractors From Relative Results

  • Returns from holdings in the Financials sector (down 14% compared to down 3% for the S&P 500 sector), combined with a higher average weighting (26% versus 16%), significantly detracted from results. Charles Schwab (down 23%), Bank of America (down 21%), Goldman Sachs (down 17%), and Capital One (down 11%) performed poorly.
  • The Fund’s underweight position in defensive segments of the market hurt relative performance:
    • Not owning companies in the Utilities sector (3% of the S&P 500) hindered results because this sector (up 24%) outperformed the market.
    • Since Telecommunication Services was the strongest sector of the market (up 25%), the Fund’s lower average weighting (1% versus 3% for the S&P 500 sector) negatively impacted results.
    • Strong performance from Wal-Mart, the Fund’s only holding in the Consumer Staples sector (up 21% compared to up 10% for the S&P 500 sector) was overshadowed by its lack of exposure to the Tobacco and Food Products industries (average 4% of the S&P 500 and up 19% and 16%, respectively).
  • Additional detractors included Express Scripts and Cigna, which were both down 13%.

Key Contributors To Relative Results

  • The Fund’s holdings in the Consumer Discretionary sector (up 9% compared to up 1% for the S&P 500 sector) contributed to results. Comcast (up 17%), Time Warner (up 15%), and Time Warner Cable (up 13% to date of merger with Charter Communications) were strong.
  • Returns from holdings in the Information Technology sector (up 5% compared to flat for the S&P 500 sector) helped results. Symantec (up 23%) and Hewlett Packard Enterprise (up 21%) performed well.
  • Returns from holdings in the Industrials sector (up 13% compared to up 6% for the S&P 500 sector) aided performance, especially Tyco International (up 35%) and ADT (up 28% to date of sale).
  • Additional contributors included Apache (up 27%), Wal-Mart (up 21%), and UnitedHealth Group (up 21%).