Dodge & Cox Stock Fund commentary for the third quarter ended September 30, 2016.
- The Fund seeks long-term growth of principal and income. A secondary objective is to achieve a reasonable current income.
- The Fund invests primarily in a diversified portfolio of equity securities. In selecting investments, the Fund typically invests in companies that, in Dodge & Cox’s opinion, appear to be temporarily undervalued by the stock market but have a favorable outlook for long-term growth. The Fund focuses on the underlying financial condition and prospects of individual companies, including future earnings, cash flow, and dividends. Various other factors, including financial strength, economic condition, competitive advantage, quality of the business franchise, and the reputation, experience, and competence of a company’s management are weighed against valuation in selecting individual securities.
- The Fund is subject to market risk, meaning holdings in the Fund may decline in value for extended periods due to the financial prospects of individual companies or due to general market and economic conditions. Please read the prospectus for specific details regarding the Fund’s risk profile.
The Dodge & Cox Stock Fund had a total return of 8.8% for the third quarter of 2016, compared to 3.9% for the S&P 500 Index. For the nine months ending September 30, 2016, the Fund had a total return of 9.5%, compared to 7.9% for the S&P 500.
Dodge & Cox Stock Fund – Market Commentary
The U.S. equity market continued to perform well in the third quarter. The S&P 500 closed at an all-time high on August 15th and ended the period up 4%. U.S. economic activity accelerated from its modest pace during the first half of 2016; notably, the labor market strengthened and household spending grew. Although the Federal Reserve (Fed) decided to leave U.S. interest rates unchanged during the quarter, it reiterated its intention to raise borrowing costs at a “gradual” pace, while watching to see how the global economy impacts the domestic outlook.
The recent combination of modest U.S. economic growth, low interest rates, and fluctuating investor sentiment has had a major impact on markets. The U.S. stock market leaders and laggards have been divided into two distinct camps:
- Traditionally stable, defensive sectors with higher dividend yields (e.g., Consumer Staples, Real Estate,Telecommunication Services, Utilities); and
- More economically sensitive sectors likely to benefit from an improving economy and higher interest rates (e.g., Energy, Financials, Information Technology).
Over the past few years, the movement of interest rates has been highly correlated with each group’s equity returns. As interest rates declined to historically low levels and investors searched for yield in the equity market, defensive stocks with “bond-like” characteristics outperformed the more cyclical stocks. In the first half of 2016, the best-performing sectors of the S&P 500 were Telecommunication Services and Utilities, while Financials and Information Technology were the worst. Conversely, during the third quarter, as U.S. Treasury yields rose modestly in anticipation of future rate increases by the Fed, Information Technology and Financials were the strongest sectors of the market, and Utilities and Telecommunication Services were the weakest. The Fund’s relative performance year to date has mirrored this shift between the two camps, with first half 2016 performance of up 1% and third quarter 2016 performance of up 9%.
We believe the Fund is well positioned based on our view that longer-term global economic growth will be better than many expect, and interest rates will rise; there is also a significant valuation gap between the Fund’s holdings and sectors where the Fund has little or no exposure. We continue to find attractive long-term investment opportunities in more economically sensitive companies, especially in Energy and Financials. For example, we recently added to the Fund’s positions in Anadarko Petroleum (a U.S.-based independent oil and gas exploration and production (E&P) company with international operations) and various financial services companies, including Bank of America, Goldman Sachs, JPMorgan Chase, and MetLife. Despite low interest rates and global economic challenges, we see opportunities because the Fund’s Financials holdings trade at relatively low valuations, have increased capital ratios, and are expanding lending across various categories. As profitability is improving, banks are returning significant capital to shareholders via share buybacks and dividends, making them a compelling alternative to other dividend-paying stocks, in our view. Additionally, if rates rise, profitability within the Financials sector should increase further.
Overall, we remain optimistic about the long-term outlook for the portfolio, which trades at a discount to the overall market (13.9 times forward earnings compared to 18.5 times for the S&P 500). The wide valuation disparities that characterize the current market offer significant opportunities for active management. 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.
Third Quarter Performance Review
The Fund outperformed the S&P 500 by 4.9 percentage points during the quarter.
Key Contributors To Relative Results
- The Fund’s average overweight position (27% versus 13%) and holdings in the Financials sector (up 10% compared to up 7% for the S&P 500 sector) contributed to results. Charles Schwab (up 25%) and Bank of America (up 18%) performed well.
- Returns from holdings in the Information Technology sector (up 18% compared to up 13% for the S&P 500 sector) helped returns. NetApp (up 47%), Hewlett Packard Enterprise (up 25%), and HP Inc. (up 25%) were strong.
- Since traditionally defensive areas of the market performed poorly, the Fund’s lack of holdings in the Utilities and Real Estate sectors (down 6% and down 2% for the S&P 500 sectors, respectively) contributed to results. In addition, the Fund’s lower average weighting in the Consumer Staples sector (down 3% for the S&P 500 sector) aided performance.
- Returns from holdings in the Energy sector (up 10% compared to up 2% for the S&P 500 sector) helped results, especially oil and gas E&P companies, Anadarko Petroleum (up 19%), Apache (up 15%), and Concho Resources (up 15%).
- Additional contributors included Sprint (up 46%) and Charter Communications (up 18%).
Key Detractors From Relative Results
- Select Health Care holdings hindered performance, especially Sanofi (down 9%), Express Scripts (down 7%), and Roche (down 6%).
- Additional detractors included Liberty Interactive (down 21%) and Twenty-First Century Fox (down 10%).
Year-to-date Performance Review
The Fund outperformed the S&P 500 by 1.7 percentage points year to date.
Key Contributors To Relative Results
- The Fund’s holdings in the Information Technology sector (up 23% compared to up 12% for the S&P 500 sector) contributed significantly to results. Symantec (up 51%) and hardware companies—Hewlett Packard Enterprise (up 51%), NetApp (up 38%), and HP Inc. (up 35%)—were strong.
- Returns from holdings in the Consumer Discretionary sector (up 16% compared to up 4% for the S&P 500 sector) aided performance. Notable contributors included Time Warner (up 25%), Charter Communications (up 16% from date of merger with Time Warner Cable), and Time Warner Cable (up 13% to date of merger).
- Returns from holdings in the Energy sector (up 22% compared to up 19% for the S&P 500 sector), combined with a higher average weighting (8% versus 7%), contributed to performance. E&P companies Concho Resources (up 48%) and