The Dodge & Cox Stock Fund had a total return of 10.3% for the first quarter of 2019, compared to 13.6% for the S&P 500 Index.
Investment Commentary
U.S. equity market returns in the fourth quarter of 2018 and first quarter of 2019 were mirror images of each other: the S&P 500 declined 14% and then rose 14% over the following three months. In the fourth quarter, volatility spiked as investors became worried about the pace of U.S. interest rate increases, a weakening global economy, and mounting geopolitical tensions Growth-oriented companies that boosted U.S. equity market returns for years fell out of favor, as a market correction ensued. In the first quarter, however, investors’ perceptions regarding macroeconomic and geopolitical variables improved, and markets recovered with technology-related stocks once again leading the increase.
Our view is that now is an opportune time to be invested in value stocks, particularly those that have come under pressure from lower interest rates. We highlight three reasons for optimism regarding our value-oriented portfolio. First, the valuation differential between value and growth stocks2 remains wide by historical standards—growth stocks are relatively expensive. As market prices inevitably move to more closely reflect fundamental value, this valuation gap should narrow. In fact, value stocks have tended to outperform when they are particularly inexpensive, as they are today. Second, interest rates remain extremely low in the United States. We believe there is a strong likelihood interest rates will trend higher over the long term. Any increase in interest rates should create meaningful upside for many value stocks, especially in the Financials sector. Third, we believe the Energy sector is poised for rebound. While the short-term direction of oil prices is difficult to forecast, the long-term fundamentals of supply and demand point to higher prices. In our opinion, these market forces are creating considerable opportunities for value investors.
As a value-oriented active manager, we are optimistic about the long-term outlook for the Fund. The portfolio remains tilted toward more economically sensitive companies poised to benefit from a rebound in value stocks: Financials comprised 24.5% of the portfolio, Communication Services 14.2%, and Energy 9.5% on March 31. In addition, we continue to find compelling long-term opportunities and recently added to selected Industrials and Energy holdings, including FedEx (FDX, Financial), Schlumberger (SLB, Financial), and United Technologies (UTX, Financial). The Fund’s portfolio of 69 equity holdings traded at 13.1 times forward earnings on March 31, a significant discount to the S&P 500’s 17.0 times forward earnings.
Over the past decade, U.S. growth stocks have outperformed value stocks by 114 percentage points.3 While this has been a challenging period for value investors, the Fund has outperformed both the U.S. value investment universe and the broad-based S&P 500, despite the latter’s exposure to growth stocks.4 A fundamental, active, value-oriented investment approach requires conviction and patience. Accordingly, Dodge & Cox maintains a long-term investment horizon and conducts rigorous due diligence to stay the course. We thank you for your continued confidence in our firm.
First Quarter Performance Review
The Fund underperformed the S&P 500 by 3.4 percentage points during the quarter.
Key Detractors From Relative Results
In the Health Care sector, the Fund’s overweight position (averaging 22% versus 15%) and weaker returns from holdings (up 4% compared to up 7% for the S&P 500 sector) detracted. CVS Health (down 17%), Cigna (down 15%), and Bristol-Myers Squibb (down 7%) performed poorly.
Strong performance from certain large technology and internet-related stocks not held by the Fund (e.g., Amazon, Apple) hurt relative results.
Within the Information Technology sector, the Fund’s holdings (up 14%) were not as strong as the S&P 500 sector (up 20%). HP Inc. (down 4%) and Juniper Networks (down 1%) lagged.
Within the Consumer Discretionary sector, the Fund’s holdings (flat) were substantially weaker than the S&P 500 sector (up 16%). Qurate Retail (down 18%) was the main detractor.
The Financials sector detracted during the period (up 8% for the Fund’s holdings and up 9% for S&P 500 sector) as the Fund’s large overweight position (averaging 26% versus 13%) negatively impacted relative results.
Key Contributors to Relative Results
While no single sector added meaningfully to relative performance, several individual holdings contributed, including Micro Focus International (up 53%), Apache (up 33%), Baker Hughes, a GE company (up 30%), Johnson Controls International (up 25%), and Charter Communications (up 22%).
- The Fund’s total returns include the reinvestment of dividend and capital gain distributions, but have not been adjusted for any income taxes payable by shareholders on these distributions or on Fund share redemptions. Index returns include dividends but, unlike Fund returns, do not reflect fees or expenses. The S&P 500 Index is a market capitalization-weighted index of 500 large-capitalization stocks commonly used to represent the U.S. equity market.
- Value stocks are the lower valuation portion of the equity market and growth stocks are the higher valuation portion.
- The Russell 1000 Growth Index had a total return of 402.0% compared to 287.7% for the Russell 1000 Value Index from March 31, 2009 through March 31, 2019.
- The Dodge & Cox Stock Fund had a total return of 346.4% compared to 287.7% for the Russell 1000 Value Index and 338.1% for the S&P 500 Index from March 31, 2009 through March 31, 2019.
