Redirection Confirmation

You'll be re-directed to the Financial Professional site.

For Financial Professionals

This site is owned and operated by Dodge & Cox on behalf of Dodge & Cox Worldwide Funds plc. Before continuing, please read the following important information and confirm that you have read and agree to these provisions and the Terms and Conditions of Use of this website.
 

This site is not intended for U.S. persons. If you are trying to find information about the Dodge & Cox Funds registered for sale in the United States or any other country, click on the country listing at the top of the page to change the country site version.

This site uses "cookies" as described in the Terms & Conditions of Use in order for Dodge & Cox to remember your personal preferences and to provide you with a better browsing experience. By continuing, you will be deemed to have accepted the site's use of cookies for this limited purpose. If you do not want this site to place cookies on your computing device, you can manage your web browser's cookie settings by navigating to the program's options menu.
 

TERMS & CONDITIONS OF USE

Use of the Dodge & Cox website ("Site"), owned and operated by Dodge & Cox®, signifies that you accept the following Terms of Use. Nothing contained in these Terms of Use is intended to modify or amend any other written agreement, if any, that may currently be in effect between you and Dodge & Cox or any funds managed by Dodge & Cox. Dodge & Cox may periodically modify these Terms of Use, and any such modifications will be effective immediately upon posting. We suggest that you periodically check these Terms of Use for modifications. If you do not agree to the Terms of Use, do not use this Site.

We suggest that you check the Terms of Use periodically for changes. The Terms of Use can be accessed from the link at the bottom of the Site pages. Dodge & Cox expressly reserves the right to monitor any and all use of this Site, without liability.


PRIVACY POLICY

Dodge & Cox expressly reserves the right to monitor any and all use of this Site; any such monitoring will be used for Dodge & Cox’s internal business purposes without liability. Dodge & Cox is committed to maintaining the confidentiality, integrity, and security of your personal and financial data. We consider this information to be private and held in confidence between you and Dodge & Cox. We would like you to know about our policies to protect the privacy of this information.

We may collect nonpublic personal information about you from:

  • You or your representative in writing, electronically or by phone (e.g., in account applications or requests for forms or literature);
  • Transactions initiated by you or made on your behalf; and
  • Information we receive from third parties, such as financial advisers, consumer reporting agencies, consultants and custodians.

We do not disclose nonpublic personal information about current or former clients or shareholders to any third parties except as necessary to effect a transaction, administer your account, or as otherwise permitted by law. For example, the Dodge & Cox Funds and Dodge & Cox Worldwide Funds use third-party transfer agents and third-party providers of systems who use your information only to process or analyze transactions you have requested. Contracts with these organizations contain provisions restricting their use of your nonpublic personal information to those purposes for which they were hired.

We restrict access to nonpublic personal information about you to those employees and service providers involved in administering or servicing your account(s) or helping us meet our regulatory obligations. We maintain physical, electronic, and procedural safeguards that comply with federal standards to protect your nonpublic personal information. In addition, our Code of Ethics, which applies to all Dodge & Cox employees, restricts the use of your nonpublic personal information.

This privacy policy applies to Dodge & Cox, the Dodge & Cox Funds, and the Dodge & Cox Worldwide Funds.
 

COOKIES POLICY

What are cookies?
A "cookie" is a small text file of coded information that is stored in your web browser or locally on the memory of your computing device by a website. Cookies enable a website to identify your device, determine when you have visited, what pages you viewed, and can store personal settings or preferences. Cookies are intended to make the web browsing experience more efficient.

How does Dodge & Cox use cookies?
The cookie settings on this website are set to allow cookies. Dodge & Cox uses cookies to improve your browsing experience by remembering your personal preferences and that you have agreed to these Terms & Conditions of Use. We do not collect any personally identifiable information about you in a cookie.

Browser cookie control
All modern web browsers provide a level of control over cookies. Users can customize a browser to accept or reject cookies. Users can also remove any cookies that have been stored by a browser. To manage your browser cookie settings, navigate to the browser's privacy options, usually found within the Tools menu of the program. Please note that while many websites require cookies to be accepted in order to function correctly, this website will still function with cookies disabled, though in a less streamlined way.
 

LIMITED LICENSE AND RESTRICTIONS ON USE

Dodge & Cox grants you a limited, revocable, nonexclusive, nontransferable license to view, store, bookmark, download, and print the pages within this Site solely for your personal, informational, and noncommercial use or as expressly authorized by Dodge & Cox in writing. You are responsible for obtaining and maintaining all equipment, services, and other materials that you need to access this Site. Dodge & Cox reserves all rights not expressly granted in these Terms of Use. Except as otherwise stated in these Terms of Use as expressly authorized by Dodge & Cox in writing, you may not:

  • Modify, copy, distribute, transmit, post, display, perform, reproduce, publish, broadcast, license, create derivative works from, transfer, sell, or exploit any reports, data, information, content, software, RSS and podcast feeds, products, services, or other materials on, generated by or obtained from this Site, whether through links or otherwise (collectively, "Materials");
  • Redeliver any page, text, image or Materials on this Site using "framing" or other technology;
  • Engage in any conduct that could damage, disable, or overburden (i) this Site, (ii) any Materials or services provided through this Site, or (iii) any systems, networks, servers, or accounts related to this Site, including without limitation, using devices or software that provide repeated automated access to this Site, other than those made generally available by Dodge & Cox;
  • Probe, scan, or test the vulnerability of any Materials, services, systems, networks, servers, or accounts related to this Site or attempt to gain unauthorized access to Materials, services, systems, networks, servers, or accounts connected or associated with this Site through hacking, password or data mining, or any other means of circumventing any access-limiting, user authentication or security device of any Materials, services, systems, networks, servers, or accounts related to this Site;
  • Modify, copy, obscure, remove or display the Dodge & Cox, Dodge & Cox Funds, or Dodge & Cox Worldwide Funds name, logo, trademarks, text, notices, or images without Dodge & Cox’s express written permission. To obtain such permission, you may e-mail us at [email protected]; or
  • Include the term "Dodge & Cox®," or any Dodge & Cox trademark or executive's name, or any variation of the foregoing, as a meta-tag, hidden textual element, or any other indicator that creates an impression of affiliation, sponsorship, or endorsement by Dodge & Cox.
     

COPYRIGHT POLICY, NOTICE AND CLAIM INFORMATION

Dodge & Cox owns and operates this Site. All Materials on this Site, whether separate or compiled, including but not limited to, text, graphics, and audio clips. Logos, buttons, images, digital downloads, data compilations, software, icons, html code and xml code, as well as all copyright, patent, trademark, trade dress, and other rights therein, are owned or licensed by Dodge & Cox® and its third-party information providers, and are protected by United States and international intellectual property laws.

Pursuant to Section 512(c)(2) of the U.S. Copyright Revision Act, as enacted through the Digital Millennium Copyright Act, Dodge & Cox designates an agent as described below to receive notifications of claimed copyright infringement by mail: 
Roberta R. Kameda, Esquire, General Counsel, Dodge & Cox, 555 California Street, 40th Floor, San Francisco, CA 94104.

The designated copyright agent can also be reached by telephone at (800) 254-8494, by fax at (415) 986-1369, and by e-mail at [email protected].


LINKING CONDITIONS

You may not link to this Site unless you comply with these linking conditions ("Linking Conditions"). Dodge & Cox grants you a limited, revocable, nonexclusive right to create a hyperlink to this Site ("Link"), provided you comply at all times with the following conditions:

  • The Link must be made to the Funds' home page at www.dodgeandcox.com.
  • The text of the Link must read either “Dodge & Cox”, “Dodge & Cox Funds”, “Dodge & Cox Worldwide Funds”,  or dodgeandcox.com. You may not use any Dodge & Cox logo or graphic or any other Dodge & Cox trademark, as part of the Link without Dodge & Cox's express written permission; and 
  • The Link and surrounding context on the linking site must not: (a) falsely represent or misrepresent any relationship between the linking site and Dodge & Cox, including suggestions of affiliation, endorsement, or sponsorship; (b) portray Dodge & Cox or its affiliates or their products or services, in a false, misleading, derogatory, or otherwise offensive manner; or (c) deliver the Materials in a framed environment or alter the layout, content, look, or feel of the Site.

If you have created a Link that conforms to these Linking Conditions, then you also may include one or more Links to any internal or subsidiary page of this Site that is located one or several levels down from the homepages (known as "deep links"), provided, however, that all such deep links must be in close physical proximity to the Link that conforms to the Linking Conditions. You may not maintain numerous or pervasive Links to this Site.
 

DATA, INFORMATION AND CONTENT

The Materials on this Site are for information, education, and noncommercial purposes only. Although Dodge & Cox may provide data, information, and content relating to investment approaches and opportunities to buy or sell securities and/or mutual funds, you should not construe any such information or other content available through this Site as legal or tax advice. You alone will bear the sole responsibility of evaluating the merits and risks associated with the use of any Materials on this Site before making any decisions based on such Materials. In exchange for using such Materials, you agree not to hold Dodge & Cox or its affiliates and their directors (trustees), officers, employees, or third-party information providers liable for any possible claim for damages arising from any decision you make based on the Materials made available to you through this Site. By providing access to other websites, neither Dodge & Cox nor any of its affiliates is recommending the purchase or sale of the stock issued by any company, nor are they endorsing services provided by any website's sponsoring organization.
 

OWNERSHIP OF OTHER MATERIALS

All trademarks, service marks, and logos appearing on this Site are the exclusive property of their respective owners.

All Dodge & Cox graphics, logos, page headers, and service names are trademarks, service marks, or trade dress of Dodge & Cox. Dodge & Cox's trademarks, service marks and trade dress may not be used in connection with any product or service that is not Dodge & Cox's, in any manner that is likely to cause confusion among customers or investors, or in any manner that disparages or discredits Dodge & Cox. Nothing contained on this Site should be construed as granting any license or right in or to any trademarks, service marks, or trade dress of Dodge & Cox.


THIRD-PARTY CONTENT

Data and other materials appearing on this Site that are provided by third parties are believed by Dodge & Cox to be obtained from reliable sources, but Dodge & Cox cannot guarantee and is not responsible for their accuracy, timeliness, completeness, or suitability for use. Dodge & Cox is not responsible for, and does not prepare, edit, or endorse, the content, advertising, products, or other materials on or available from any website owned or operated by a third party that is linked to this Site via hyperlink. The fact that Dodge & Cox has provided a link to a third party's website does not constitute an implicit or explicit endorsement, authorization, sponsorship, or affiliation by Dodge & Cox with respect to such website, its owners, providers, or services.  You will use any such third-party content at your own risk.
 

WARRANTY DISCLAIMERS

YOU EXPRESSLY UNDERSTAND AND AGREE THAT:

THERE ARE NO IMPLIED OR EXPRESSED WARRANTIES ON THE MATERIALS IN THIS SITE; THE MATERIALS ARE PROVIDED "AS IS" AND "AS AVAILABLE BASIS." DODGE & COX, AFFILIATES, AGENTS, DIRECTORS (AND TRUSTEES), OFFICERS, EMPLOYEES, LICENSORS AND ANY THIRD-PARTY INFORMATION PROVIDERS AND VENDORS DISCLAIM, TO THE FULLEST EXTENT UNDER APPLICABLE LAW, ANY WARRANTY OF ANY KIND, WHETHER EXPRESS OR IMPLIED, AS TO ANY MATTER WHATSOEVER RELATING TO THIS SERVICE, INCLUDING WITHOUT LIMITATION THE IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, NONINFRINGEMENT, AND ALL WARRANTIES REGARDING SECURITY, CURRENCY, CORRECTNESS, QUALITY, ACCURACY, COMPLETENESS, RELIABILITY, PERFORMANCE, TIMELINESS, OR CONTINUED AVAILABILITY, WITH RESPECT TO (I) THE SITE; (II) ANY MATERIALS, PRODUCTS, OR SERVICES AVAILABLE ON OR THROUGH THE SITE; (III) USE OF THE SITE, MATERIALS, PRODUCTS, OR SERVICES; AND (IV) THE RESULTS OF THE USE OF THE SITE, MATERIALS, PRODUCTS, OR SERVICES. FURTHER, DODGE & COX, AFFILIATES, DIRECTORS (AND TRUSTEES), OFFICERS, EMPLOYEES, AGENTS, LICENSORS, AND ANY THIRD-PARTY INFORMATION PROVIDERS AND VENDORS EXPRESSLY DISCLAIM ALL WARRANTIES WITH RESPECT TO ANY DELAYS OR ERRORS IN THE TRANSMISSION OR DELIVERY OF ANY MATERIALS, PRODUCTS, OR SERVICES AVAILABLE THROUGH THIS SITE. EXCEPT AS PROVIDED BY LAW, NEITHER DODGE & COX NOR ITS THIRD-PARTY INFORMATION PROVIDERS AND VENDORS HAS ANY RESPONSIBILITY TO MAINTAIN THE MATERIALS, PRODUCTS, OR SERVICES OFFERED ON THE SITE OR TO SUPPLY CORRECTIONS, UPDATES, OR RELEASES FOR THE SAME. USE OF THIS SERVICE IS AT YOUR OWN RISK. REFERENCE TO A FUND OR SECURITY ANYWHERE ON THIS WEB SITE IS NOT A RECOMMENDATION TO BUY, SELL, OR HOLD THAT OR ANY OTHER SECURITY. IF YOU LIVE IN A STATE THAT DOES NOT ALLOW DISCLAIMERS OF CERTAIN WARRANTIES, SOME OF THE ABOVE EXCLUSIONS MAY NOT APPLY TO YOU. THIS WARRANTY GIVES YOU SPECIFIC LEGAL RIGHTS, AND MAY HAVE OTHER RIGHTS, WHICH VARY FROM JURISDICTION TO JURISDICTION.
 

LIABILITY AND INDEMNITY

ANY MATERIALS DOWNLOADED OR OTHERWISE OBTAINED THROUGH THIS SITE ARE DONE AT YOUR OWN RISK. YOU ARE SOLELY RESPONSIBLE FOR ANY DAMAGE TO YOUR COMPUTER SYSTEM OR OTHER EQUIPMENT, OR LOSS OF DOWNLOADED OR OBTAINED DATA THAT RESULTS FROM SUCH DOWNLOAD.

NEITHER DODGE & COX NOR ITS AFFILIATES, DIRECTORS (AND TRUSTEES), OFFICERS, EMPLOYEES, AGENTS, LICENSORS, OR ANY THIRD-PARTY INFORMATION PROVIDERS AND VENDORS WILL BE LIABLE FOR ANY DIRECT, INDIRECT, INCIDENTAL, SPECIAL, CONSEQUENTIAL, PUNITIVE, OR EXEMPLARY DAMAGES, INCLUDING BUT NOT LIMITED TO, DAMAGES FOR LOSS OF PROFITS, REVENUE, INCOME, GOODWILL, USE, DATA, OR OTHER INTANGIBLE LOSSES, OR DAMAGES CAUSED BY THEFT, UNAUTHORIZED ACCESS, SYSTEMS FAILURE, OR COMMUNICATIONS LINE FAILURE, OR THE COST OR PROCURING SUBSTITUTE GOODS OR SERVICES, CAUSED BY THE USE OF OR INABILITY TO USE THE SITE, MATERIALS OR ANY PRODUCTS OR SERVICES PROVIDED HEREIN, OR ANY OTHER MATTER RELATING TO THIS SITE, EVEN IF DODGE & COX HAS BEEN ADVISED OF THE POSSIBILITY OF SUCH DAMAGES. SOME JURISDICTIONS DO NOT ALLOW THE EXCLUSION OR LIMITATION OF INCIDENTAL OR CONSEQUENTIAL DAMAGES, SO THE ABOVE EXCLUSIONS OR LIMITATIONS MAY NOT APPLY TO YOU. TO THE EXTENT THAT A JURISDICTION DOES NOT PERMIT THE EXCLUSION OR LIMITATION OF LIABILITY AS SET FORTH HEREIN, THE LIABILITY OF DODGE & COX AND ITS AFFILIATES, SUBSIDIARIES, DIRECTORS, OFFICERS, EMPLOYEES, AGENTS, LICENSORS, AND ANY THIRD-PARTY INFORMATION PROVIDERS AND VENDORS IS LIMITED TO THE EXTENT PERMITTED BY LAW IN SUCH JURISDICTIONS.

You agree to indemnify, defend, and hold harmless Dodge & Cox, its affiliates, and each of its and their officers, directors (and trustees), employees, and agents, from and against all claims, demands, liabilities, damages, losses, or expenses, including attorney's fees and costs, arising out of or related to your improper access to or use of this Site, or any violation by you of these Terms of Use.

Dodge & Cox does not claim that materials in this Site are appropriate or available for use in all locations. Because of the global nature of the Internet, you agree to comply with all local rules with respect to your online conduct, including all laws, rules, codes, and regulations of the country in which you reside and the country from which you access this Site, including without limitation, all laws, rules, codes, regulations, decrees, acts, orders, directives, legislation, bills, and statutes pertaining to tax, contracts, intellectual property, securities, e-commerce, banking, technology, computers, fraud, and privacy.

Each investment product and service referred to on this Site is intended to be made available only to persons where that product or service is registered and/or licensed for sale or where such registration or licensing is not required. This Site will not be considered a solicitation for or offering of any investment product or service to any person in any jurisdiction where such solicitation or offering would be illegal.
 

TIMELINESS OF CONTENT

All content on this Site is presented only as of the date published or indicated, and may be superseded by subsequent market events or for other reasons. In addition, you are responsible for setting the cache settings on your browser to ensure you are receiving the most recent data.


TERMINATION

The rights granted to you herein terminate immediately if you fail to comply with the Terms of Use. Dodge & Cox, in its sole discretion, reserves the right to temporarily or permanently terminate your access to and use of this Site at any time and for any reason whatsoever, without notice or liability. Dodge & Cox will not be liable to you or any third party for any termination of your access to or use of this Site.
 

INTEGRATION AND SEVERABILITY

If any provision of these Terms of Use is deemed unlawful, void, or for any reason unenforceable, then that provision will be deemed severable from these Terms of Use and will not affect the validity and enforceability of the remaining provisions. The preceding Terms of Use represent the entire agreement between Dodge & Cox and the user relating to the subject matter herein.

Terms of Use as of: February 2022

 

Paper

U.S. Inflation Risks and Their Investment Implications

July 2022

 

Key Takeaways

  • U.S. inflation has worsened over the past few months, as the Russia-Ukraine conflict and renewed lockdowns in China emerged as complicating factors. In turn, the Federal Reserve has accelerated monetary policy tightening, while supply chain disruptions and the labour market appear to be somewhat loosening.
  • Our investment team assesses a range of macroeconomic outcomes that could impact the investments we are making on an individual, bottom-up basis. Rather than relying on a single point forecast, our process involves active debate and stress testing under a range of potential outcomes.
  • In our base-case scenario, we expect U.S. inflation (as measured by personal consumption expenditures) to ultimately settle back into a range of 2.0% to 3.0% over our three- to five-year investment horizon. However, we draw wide error bands around our projections and contemplate alternative scenarios, including those in which inflation fails to decline convincingly.
  • The Dodge & Cox Worldwide Funds are broadly diversified, feature numerous investment drivers, and are well positioned, in our opinion, for a variety of macroeconomic outcomes.

Putting Inflation Dynamics In Context

U.S. inflation has risen to the highest level since the early 1980s. In fact, the spike since last summer is one of the fastest in recent history. As of May 2022, year-over-year headline personal consumption expenditures (PCE)1 inflation stood at 6.3% and core PCE2 at 4.7% (see Figure 1). In turn, as of June 2022, the same measures based on the Consumer Price Index (CPI)3 stood at 9.1% and 5.9%, respectively. The worsening of inflation dynamics over the past few months has surprised policy makers and analysts who expected a more tame and temporary overshoot relative to the Federal Reserve’s 2% target. In addition, the near-term inflation picture remains mixed as complicating factors have emerged, some putting upward pressure on inflation (e.g., Russia’s invasion of Ukraine and its impact on energy and food commodity prices, ongoing supply-chain disruptions) and others putting downward pressure (e.g., monetary policy tightening).

In evaluating these and other factors, we continue to think that U.S. inflation is likely to retreat to levels of around 2.0% to 3.0% over our extended investment horizon. However, we also continue to assess scenarios where inflation falls below or stays above that range. We are paying particular attention to the latter scenario, as inflation risks appear skewed to the upside for reasons discussed below. In line with our investment horizon, we take a long-term perspective on these issues, both when assessing the outlook and when making investment decisions. In the rest of this paper, we discuss the evolution of key drivers of the inflation outlook from a multi-year perspective, with an emphasis on drivers that have emerged more recently, but could have long-term consequences. We also lay out our latest views aligned with our base-case analysis and alternative scenarios. Finally, we walk through the implications for the Dodge & Cox Worldwide Funds.

Source: Federal Reserve.

Persistently high inflation erodes the real value of investment capital, requiring a higher nominal return to maintain purchasing power. It also introduces distortions that may affect real economic outcomes, including policy implementation and planning by households and businesses. These are just some of the ways in which the inflation outlook matters from an investment standpoint, and they are reasons for taking inflation risks seriously.

Assessing U.S. Inflation Drivers

At any point in time, various factors shape potential inflation scenarios. These can change over time—in magnitude, importance, and direction. Some of them are more cyclical (e.g., the economic recovery from the initial stages of the COVID-19 pandemic) and others are more structural (e.g., demographics). For analytical purposes, it is useful to divide these factors into two simple buckets: factors generally adding upward inflationary pressures and those adding downward inflationary pressures over our investment horizon of the next three to five years. The tug of war between these two will determine the overall inflation rate.

Factors Adding Upward Inflationary Pressures

  • Post-pandemic aggregate demand recovery relative to supply: Driven by an extraordinary amount of fiscal stimulus, easy monetary policy, and pent-up savings, aggregate demand continues to rise, outstripping supply as the economic impact of the pandemic has subsided, particularly in goods sectors impacted by supply chain disruptions. Since late 2020 and throughout 2021, the contribution of goods inflation rose strongly relative to services, reflecting changed consumption patterns from consumers. More recently, services inflation has risen alongside the broader opening of the U.S. economy, while goods inflation has moderated (see Figure 2).

Source: Bureau of Labour Statistics.

  • Potential for wage-price spiral: The unemployment rate has fallen from a peak of 14.7% in 2020 to 3.6% as of June 2022. The job vacancy and resignation rates are at record levels, indicating a tight labour market. However, job gains have moderated from earlier in the recovery. Wages are rising: average hourly earnings have exceeded 5% on a year-over-year basis for every month since January 2022. This pace is inconsistent with the Fed’s 2% inflation target and risks an entrenchment of “cost push” inflation driven by future wage negotiations. In addition, the pandemic unleashed a trend of high quit and job-switching rates (so-called “Great Resignation”), which tends to add upward pressure on wages due to increased competition across employers.
  • A persistent Russia-Ukraine conflict: Continued or worsening disruptions of commodity markets due to the conflict are likely to lead to higher pass-through of rising costs to consumer prices. The two countries together supply over a quarter of the world’s fertiliser and wheat supplies. The conflict has thus disrupted large segments of global food markets, with a concomitant upward pressure on prices. In addition, the invasion has disrupted energy markets in myriad ways, as many private and public organisations have either divested from Russian oil and gas supplies or have set plans to do so.
  • Supply-chain challenges persist: While supply-chain bottlenecks have recently improved, various aggregate indexes, such as the NY Fed’s Global Supply Chain Pressures Index, still show highly elevated values (see Figure 3). COVID-related lockdowns in China are likely to continue as long as the Chinese government continues to pursue its zero-COVID strategy. These, in turn, put upward cost pressures on a variety of global supply chains.
  • Federal Reserve’s new policy framework: In adopting an average inflation target of 2.0% over time, the Fed signalled that it would compensate for a prolonged period of low inflation by allowing moderate rises above the target in subsequent years. The new framework also reflected a change toward reducing shortfalls of employment relative to its maximum sustainable level, implying more tolerance for low unemployment rates. In practice, however, the threat of excessively high inflation has become a serious challenge to these principles.

Source: NY Federal Reserve. Standard Deviation measures the volatility of the Index's returns. Higher Standard Deviation represents higher volatility..

Factors Adding Downward Inflationary Pressures

  • Tightening of fiscal and monetary policy: Fiscal stimulus peaked in mid-2021 and the pullback has likely detracted from growth since then. That is, the so-called “fiscal impulse” has turned negative, which is unlikely to change in the current political context. In addition, since the end of 2021, the Fed has recognised that many inflationary factors are no longer “transitory” and has shifted its policy stance significantly to temper inflation:
    • First, it has already hiked the federal funds rate from an upper limit of 0.25% to 1.75% and substantially accelerated the pace (moving from a 25bp5 to a 50bp to a 75bp increment).
    • Second, it has projected a policy rate above 3% over the next few years. This implies a more restrictive monetary policy stance relative to neutral, which in turn should slow down economic activity and loosen the labour market.
    • Third, it announced that it would start reducing its balance sheet in June (the so-called “quantitative tightening” process), in a quicker and larger way than in the 2017-19 period (see Figure 4).

Source: Federal Reserve.

The interest rate markets have priced in much of this monetary tightening, with the 2-year yield rising from 0.6% in early December 2021, to above 3% at present. Overall, these policy moves (and follow-on market moves) contribute to a tightening of financial conditions that aims to eventually slow down economic activity, re-equilibrate aggregate demand and supply, and generate downward pressure on inflation.6

  • Globalisation: The ability to source labour and inputs globally enables producers to reduce costs throughout supply chains. Over the past decade or so, the share of trade in global GDP has somewhat declined, and “peak” globalisation may be behind us, but it remains high from a historical standpoint. In addition, within country blocs, flow of goods, services, and capital have intensified (e.g., North America, Eurozone). This leads to efficiencies of scale, comparative advantages, and increased competition, all of which contribute to lower costs.
  • Technology: By increasing labour productivity, technological improvements can lower the cost of production and services. In addition, the rise of online shopping, enabled by technological advances, empowers consumers to compare prices across producers. The result is greater transparency, more competition, and lower prices.
  • Less bargaining power on wages: With the reduced role of labour unions, workers lack bargaining power to push up wages. At the same time, the “gig” economy, which tends to increase labour competition and drive down wages, is a powerful and growing force.
  • Income inequality: Higher income households historically save more than lower income households. As a greater percentage of society’s wealth resides with higher earners than in the past, a greater amount of funds flow into savings and investment versus demand for goods and services.
  • Anchoring effects: After decades of low inflation, market participants may be less sensitive to data pointing toward a higher inflationary regime in the future. A greater degree of circumstantial evidence may be required to change expectations for higher prices going forward. For example, after spiking earlier this spring, long-term market-based inflation expectation measures (10-year “breakevens”) have declined from 3.0% to around 2.3%. Shorter-term measures (2-year “breakevens”) have declined significantly as well, but remain higher than long-term measures. Similar messages emerge from survey-based measures, where long-term inflation expectations have risen more moderately than short-term inflation expectations.

Our View

In line with our investment horizon, our economic forecasts are long term in nature and consider a range of environments. In accordance, we formulate a range of inflation scenarios, including a baseline that we think is most likely to materialise, a down alternative, and an up alternative. We build these models incorporating a wide range of inputs—including the inflation drivers mentioned above—and active debate within our team. In our base (most likely) case, we do not believe the current high levels of inflation will persist beyond the short run. We currently expect that it will ultimately settle in a range of approximately 2.0% to 3.0% over our investment horizon. Our up case embeds a larger and more sustained overshoot of inflation (3.0% to 4.5%), while in our down case, inflation would return to very subdued levels (1.0% to 2.0%). These two cases represent plausible alternatives, not tail-risk extreme outcomes. At this point in time, we would assess a somewhat higher likelihood of the up case transpiring than the down case. This is because inflationary pressures are currently strong and tend to remain elevated for longer as consumers and businesses adjust to policy tightening. In addition, commodity price pressures stemming from the Russia-Ukraine conflict appear unlikely to abate in the near term.

The up inflation scenario may correlate with a significant slowdown of economic activity (often referred to as “stagflation”).7 This is a material risk to the economic outlook, and we have carefully assessed its possible investment implications. On the growth side, concerns centre on the possible need for even more aggressive monetary tightening, lingering supply chain problems, low consumer confidence, internal and external (geo)political risks, and the historically low odds for the Federal Reserve to achieve reductions of inflation with only moderate costs on economic activity. That said, favourable economic momentum, strong balance sheets, improved monetary policy communication/transmission channels, and lack of major domestic/external imbalances, make it less likely to see stagflation dynamics like in the 1970s. Instead, we think that if a recession were to occur, it would most likely be a shallow one. And if it was driven by excessive monetary tightening, the latter would at least ultimately quench the inflation part of the stagflation equation. In sum, given the present context, we think there is only a low probability that we will see a deep or sustained period of stagflation over our investment horizon.

Building Our View Through Bottom-Up Research

We build our fixed income and equity portfolios based on our assessment of fundamentals and valuation for individual issuers and securities. Through this bottom-up process, our Global Industry, Fixed Income, and Macro Analysts incorporate a number of macroeconomic factors (including inflation) into their models. Our bottom-up research informs these inputs. For example, frequent conversations with company management teams enable us to benefit from their real-time observations on pricing, among other factors. In fact, conversations with company teams over the course of 2021 helped us gauge bottom-up inflationary pressures pointing to “this time is different” dynamics, which we incorporated in our macro discussions. Meanwhile, our Investment Committees review similar factors along with economic scenarios as they evaluate individual investments, broad portfolio positioning, and overall portfolio risk. In each case, our investment team seeks to assess a range of outcomes that could impact the investments we are making on a bottom-up basis.

Implications For The Dodge & Cox Worldwide Funds

In the face of a challenging inflation outlook, our investment team has engaged companies and issuers to identify both areas of possible risk and opportunity in the markets. Our Global Industry Analysts have modelled a recession scenario characterised by high inflation, in addition to our customary three-scenario framework. Our goal is to think creatively about the possible range of outcomes ahead, assess the impact these alternative contexts may have in our portfolios, and determine what expectations are embedded in market prices. This analysis is highly granular, informed by our knowledge of each industry and its historical context. It is also consistent and centralised, as all analysts work with the same sets of baseline assumptions when looking at company-by-company results. Lastly, our Macro Analysts have also engaged in similar exercises to analyse the impact that the same assumptions for a U.S. recession with high inflation may have in other countries.

As we have done in the face of previous macro shocks, our Equity and Fixed Income investment team works in unison, leveraging our knowledge of industries and markets to both identify areas of vulnerability and opportunity. Informed by these analyses, below we highlight certain portfolio positions and sectors that historically have shown a greater sensitivity, both positive and negative, to inflationary environments.

Fixed Income

Defensive Duration8 Positioning

Inflation expectations are incorporated into long-term interest rates so that, all else being equal, an increase in market expectations for inflation would result in rising yields. In terms of portfolio impact, a further jump in inflation expectations would likely result in negative near-term total returns for fixed income investments as we saw in 2021 and have experienced so far in 2022. However, we believe the Dodge & Cox Worldwide Funds—Global Bond Fund is well positioned from a relative return standpoint because it has less exposure to the long end of the yield curve, where inflation-driven rate increases are most likely to occur. Of course, if market expectations for inflation decline and yields return to the levels of late 2021, the reverse would likely benefit broad fixed income returns, but could hamper the Global Bond Fund's relative performance.

We continue to believe it is prudent to position the Global Bond Fund with a shorter-than-benchmark duration, and we shortened portfolio duration by approximately half of a year in the second half of 2021. We did so because we saw a greater chance of long-term interest rates exceeding expectations over our investment horizon. More recently, with interest rates and portfolio yields substantially higher, we have nudged duration longer in the portfolio, while retaining the shorter bias. Inflation could remain persistently high for a longer period of time, causing the Fed to respond more aggressively than the market is pricing. Additionally, fixed income benchmarks have lengthened duration over the past decade due to lower rates and issuance patterns. In our opinion, the embedded interest rate risk in broad fixed income benchmarks does not represent a favourable risk-reward tradeoff relative to the current level of income.

Significant Credit Sector Weighting

Though we have reduced the Global Bond Fund's credit weighting from two years ago, it still features a meaningful weighting in credit securities. This is an important consideration because credit spreads generally are negatively correlated with rate increases during economic expansions. While far from a guarantee, excess returns from credit tend to be positive in rising-rate environments, which could benefit the portfolio if inflation rises even further and pushes rates higher. Moreover, within credit, the Fund currently holds issuers exposed to commodity prices, in particular oil and natural gas, which are likely to benefit from high inflation. The portfolio does not hold these issuers specifically as an inflation hedge, although it is a helpful secondary benefit.

However, inflation at the high end of our up case does present some risks to the portfolios’ credit holdings. If inflation remains stubbornly high, it will add pressure on the Fed to raise rates more aggressively, potentially inducing a recession. If this plays out, we expect short-term rates to move significantly higher, which when combined with recession risk, may weigh on credit securities and other risk assets.

Yield Advantage

The Global Bond Fund also has a higher yield than its performance benchmark due to our emphasis on Agency9 MBS and Credit. A higher yield can be helpful in rising-rate environments as it mitigates price losses and allows for reinvestment of more income at higher rates. Across all environments, income—and the compounding of income—is an important component of total return. From these higher starting yields, we believe more attractive returns are available for fixed income.

Equity

We believe the Dodge & Cox Worldwide Funds—U.S. Stock Fund and Global Stock Fund are well positioned for higher U.S. inflation, rising interest rates, and narrowing valuation disparities. These portfolios have significant exposure to U.S. Financials and the Energy sector,10 which are beneficiaries of an inflationary environment.

Key drivers of bank profitability—such as net interest margins and loan growth—generally benefit from higher levels of inflation, interest rates, and economic growth. Our U.S. financial services holdings offer inexpensive valuations and are geared toward a long-term economic recovery. Despite higher commodity prices and the risk of a U.S. recession in the near term, we believe the U.S. economy will expand over our three- to five-year investment horizon. Overall, consumer balance sheets are strong, and spending on gasoline is a lower share of disposable income than in the past. The fading impact from COVID-19 continues to provide a growth tailwind to many industries.

In addition, higher energy prices and increased energy demand have clearly benefited energy producers and servicers in past commodity cycles. With much higher oil and natural gas prices and companies restraining capital spending, the equity Funds’ energy holdings now trade at very attractive free cash flow yields,11 creating the conditions for potentially higher capital return. We expect energy prices will remain high over our investment horizon, despite intensifying efforts to decarbonise the global economy and the growing number of technological innovations in alternative energy sources.

While we are enthusiastic about these overweight positions, there are inherent risks. For example, the Fed may raise interest rates more aggressively in its attempt to combat higher than desired inflation, which could hurt credit costs and economic growth. Furthermore, our outlook for energy prices is constructive over our investment horizon, however efforts to decarbonise the global economy have intensified alongside technological innovations in alternative energy sources.

Conversely, the equity Funds remain underweight high-valuation growth stocks that we believe are more at risk due to lofty expectations for their future performance. Over the past decade, many high-growth technology companies with high valuations benefited from a declining interest rate environment, but they have underperformed in the first half of 2022 as interest rates have increased. Going forward, higher-than-expected inflation and interest rates may disproportionally impact companies with expensive valuations driven by high expectations for far-off cash flows. Given what we believe to be full valuations among many of these companies, the equity Funds, for example, remain underweight the Information Technology sector. Nevertheless, as valuations and prices change in this sector, we are actively analysing potential investment opportunities on a selective basis.

We remain optimistic about the prospects for the Funds, which we actively manage for the long term and diversify across a range of sectors and investment themes. Beyond sector and geographic diversification, we evaluate other portfolio exposures and seek to mitigate the risks. We continually evaluate new risk/reward opportunities available in the market. Volatility can provide opportunities to add and trim various positions, so we stay nimble and seek to take advantage of dislocations when they present themselves.

Conclusion

Our goal at Dodge & Cox is to preserve and enhance the purchasing power of our Fund shareholders’ investment dollars. With this in mind, we carefully consider the impact of numerous factors, including inflation, on an investment or portfolio. The Dodge & Cox Worldwide Funds have exposure to areas of the market that are poised to benefit from higher inflation, but ultimately they are well positioned across a range of economic environments given their diversified portfolios and various investment drivers.

Contributors

David Hoeft
Chief Investment Officer, Investment Committee Member, D&C Board Member
Tom Dugan
Director of Fixed Income, Investment Committee Member, D&C Board Member
Phil Barret
Investment Committee Member, Global Industry Analyst, D&C Board Member
Jose Ursua
Investment Committee Member, Fixed Income Analyst

Disclosure

This is a marketing communication. Dodge & Cox Worldwide Funds plc are registered for distribution in multiple EU Member States under the UCITS Directive. The Funds may terminate the arrangements made for the marketing of any fund or share class in a member state at any time by using the process contained in Article 93a of the UCITS Directive. The Funds are registered in Ireland and are available only to residents of those jurisdictions where allowed by applicable law. Purchase orders from U.S. investors or other ineligible investors will not be accepted. To obtain more information about the Funds before making any final investment decisions, please refer to the Funds' prospectus and key investor information document at dodgeandcoxworldwide.com. A summary of investor rights is also available in English at dodgeandcoxworldwide.com.

Investment prices may increase or decrease, sometimes suddenly and unpredictably, due to general market conditions. Local, regional, or global events such as war, acts of terrorism, the spread of infectious illness or other public health issues, recessions, or other events could also have a significant impact on a Fund and its investments. A Fund's performance could be hurt by equity risk, market risk, manager risk, liquidity risk, geographic risk and derivatives risk. Investments in foreign securities can involve political, economic and currency risks, greater volatility and differences in accounting methods. These risks are greater for emerging markets. In addition, fixed income performance could be hurt by interest rate risk, credit risk, below-investment grade securities risk, mortgage- and asset-backed securities risk, to-be-announced transaction risk, and call risk.

The above information is not a complete analysis of every material fact concerning any market, industry, or investment. Data has been obtained from sources considered reliable, but Dodge & Cox makes no representations as to the completeness or accuracy of such information. Opinions expressed are subject to change without notice. The information provided is historical and does not predict future results or profitability. This is not a recommendation to buy, sell, or hold any security and is not indicative of Dodge & Cox’s current or future trading activity. Any securities identified are subject to change without notice and do not represent a Fund’s entire holdings.

Endnotes

1. Personal consumption expenditures (PCE) measure how much consumers spend on durable and non-durable goods and services. PCE is the Federal Reserve’s preferred measure for inflation.

2. Core PCE prices exclude food and energy prices.

3. The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.

4. The NY Fed's Global Supply Chain Pressures Index tracks the state of global supply chains using data from the transportation and manufacturing sectors.

5. One basis point is equal to 1/100th of 1%.

6. Dudley, William. “The Importance of Financial Conditions in the Conduct of Monetary Policy.” Federal Reserve Bank of New York, 30 March 2017. https://www.newyorkfed.org/newsevents/speeches/2017/dud170330

7. Stagflation occurs when the inflation rate is high, economic growth rate slows, and unemployment remains high.

8. Duration is a measure of a bond’s (or a bond portfolio’s) price sensitivity to changes in interest rates.

9. The U.S. Government does not guarantee the Fund’s shares, yield, or net asset value. The agency guarantee (by, for example, Ginnie Mae, Fannie Mae, or Freddie Mac) does not eliminate market risk.

10. Unless otherwise specified, all weightings and characteristics are as of 30 June 2022.

11. Free cash flow is the cash a company generates after paying all expenses and loans. The free cash flow yield compares a company's free cash flow per share with its market price per share. A high free cash flow yield means a company is generating enough cash to satisfy its debt and other obligations.