The Dodge & Cox Stock Fund had a total return of 2.6% for the second quarter of 2019, compared to 4.3% for the S&P 500 Index. For the six months ended June 30, 2019, the Fund had a total return of 13.1%, compared to 18.5% for the S&P 500.
I N V E S T M E N T C O M M E N TA RY
After posting strong returns in the first quarter of 2019, the U.S. equity market continued to climb during the second quarter: the S&P 500 reached an all-time high in late June and ended the first half of the year up 19%. Continued U.S. job growth and the Federal Reserve’s consideration of lower interest rates propelled U.S. stocks to record levels. Growth stocks outperformed value stocks2 as technology-related companies surged during the six- month period: Information Technology (up 27%) and Consumer Discretionary (up 22%) were the best-performing sectors of the S&P 500, whereas Health Care (up 8%) and Energy (up 13%) lagged the most. These market dynamics extended a longer-term trend.
Over the last decade, U.S. growth stocks have outperformed value stocks by a cumulative 107 percentage points.3 During this challenging period for value investors, the Fund has outperformed the U.S. value investment universe by 27 percentage points.4 The valuation differential between value - and growth-oriented stocks remains wide by historical standards—growth stocks are relatively expensive. This valuation gap should narrow as market prices move to more closely reflect fundamental value. Historically, many value stocks have tended to outperform when they are particularly inexpensive, as they are today. We have strong conviction in our value-oriented, active investment approach and continue to believe now is an opportune time to be invested in value stocks.
In addition, U.S. interest rates are extremely low in a historical context, and there is an overwhelming expectation in the market that they will remain “lower for longer.” We believe current valuations may already reflect most of these beliefs about rates. The future market “surprise” may be rate hikes from today’s low levels, and we think there is a strong likelihood this will happen over the long term. Any increase in interest rates should create meaningful upside for many value stocks, especially in the Financials sector, where the Fund is significantly overweight. Of course, a number of other factors can also impact returns for Financials, including loan growth and credit quality.
We are optimistic about the long-term outlook for the Fund and continue to find compelling opportunities, more recently in the Health Care and Energy sectors. For example, we added to Cigna (CI, Financial), one of the largest and most diversified health care services organizations in the United States. The company is trading at nine times forward earnings, an inexpensive valuation given its solid business franchise and management’s strong execution track record. Cigna acquired Express Scripts, a leading pharmacy benefit manager, at the end of 2018, and we believe there will be significant cost savings from the deal. The combined company is generating meaningful free cash flow that can be used to reduce debt, repurchase shares, and drive earnings growth.
In Energy, we recently added to the Fund’s holdings of Concho Resources and National Oilwell Varco, among others. While the short-term direction of oil prices is difficult to forecast, we continue to believe the long-term fundamentals of supply and demand point to higher prices. In our opinion, these market forces are creating considerable opportunities for investors.
We continue to believe the rewards of active management are most likely to accrue to those investors who have the discipline to maintain a long-term investment horizon. Thank you for your continued confidence in Dodge & Cox.
S E C O N D QU A RT E R P E R F O R M A N C E R E V I E W
The Fund underperformed the S&P 500 by 1.7 percentage points during the quarter.
K E Y D E T R A C T O R S F R O M R E L AT I V E R E S U LT S
The Fund's overweight position (averaging 21% versus 14%) and relative performance in the Health Care sector (flat compared to up 1% for the S&P 500 sector) impeded results. Eli Lilly (down 14%) and Bristol-Myers Squibb (down 4%) were particularly weak.
The Fund’s holdings in the Consumer Discretionary sector (down 8%) trailed the S&P 500 sector (up 5%). Qurate Retail (down 22%) lagged.
In the Financials sector, the Fund’s holdings (up 4%) were weak compared to the S&P 500 sector (up 8%). Bank of New York Mellon (down 12%) and Charles Schwab (down 6%) were key detractors.
FedEx (down 9%) and energy holdings Occidental Petroleum (down 23%), Apache (down 16%), and Baker Hughes, a GE Company (down 10%) had a negative impact.
K E Y C O N T R I B U T O R S T O R E L AT I V E R E S U LT S
Returns from holdings in the Communication Services sector (up 6% compared to up 4% for the S&P 500 sector), combined with a higher average weighting (15% versus 10%), bolstered relative results. Charter Communications (up 14%) performed well.
Notable contributors included Anadarko Petroleum (up 56%), TE Connectivity (up 19%), MetLife (up 18%), Johnson Controls International (up 13%), and Capital One Financial (up 12%).
Y E A R - T O - D AT E P E R F O R M A N C E R E V I E W
The Fund underperformed the S&P 500 by 5.4 percentage points year to date.
K E Y D E T R A C T O R S F R O M R E L AT I V E R E S U LT S
The Fund’s average overweight position (21% versus 14%) and lower returns in the Health Care sector (up 4% compared to up 8% for the S&P 500 sector) hurt results. Cigna (down 17%), Bristol-Myers Squibb (down 11%), and Sanofi (up 3%) were weak.
Strong performance from several large internet and technology-related stocks not held by the Fund (e.g., Amazon, Apple) detracted from relative results. The negative impact was substantial in Consumer Discretionary and Information Technology (the best- performing S&P 500 sectors), where the Fund was underweight throughout the period.
In the Consumer Discretionary sector, the Fund’s holdings (down 7%) trailed the S&P 500 sector (up 22%). Qurate Retail (down 37%) and Gap (down 29%) performed poorly.
In the Information Technology sector, the Fund’s holdings performed well (up 22%) but lagged the S&P 500 sector (up 27%).
The Fund’s higher average weighting (26% versus 13%) and weaker returns from holdings in the Financials sector (up 13% compared to up 17% for the S&P 500 sector) hampered results. Bank of New York Mellon (down 5%), Charles Schwab (down 2%), and Wells Fargo (up 5%) lagged.
Occidental Petroleum (down 16%) and FedEx (up 3%) also detracted.
K E Y C O N T R I B U T O R S T O R E L AT I V E R E S U LT S
The Fund's average overweight position (15% versus 10%) and holdings in the Communication Services sector (up 21% compared to up 19% for the S&P 500 sector) aided relative results. Zayo Group Holdings (up 44%) and media companies DISH Network (up 54%), Charter Communications (up 39%), and Comcast (up 25%) were key contributors.
Holdings Anadarko Petroleum (up 63%), Micro Focus International (up 56%), Johnson Controls International (up 41%), and American Express (up 31%) were standout performers.
- 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 351.7% compared to 245.0% for the Russell 1000 Value Index from June 30, 2009 through June 30, 2019.
- The Dodge & Cox Stock Fund had a total return of 272.0% from June 30, 2009 through June 30, 2019.
