Dogs Of The Dow A Winning Strategy In 2018

With the 2018 investing year now closed, one strategy that turned out to be a winning one was the Dogs of the Dow strategy. The Dogs of the Dow strategy is one where investors select the ten stocks that have the highest dividend yield from the stocks in the Dow Jones Industrial Average Index (DJIA) after the close of business on the last trading day of the year. Once the ten stocks are determined, an investor invests an equal dollar amount in each of the ten stocks and holds them for the entire next year. The popularity of the strategy is its singular focus on dividend yield.

I have written about this from time to time and early in 2018 the Dow Dogs were underperforming both the S&P 500 Index and the Dow Jones Industrial Average Index. This was on top of the fact the Dow Dogs underperformed the market in 2017. Through the first half of 2018 the Dow Dogs continued their lagging ways; however, a more volatile market in the second half of last year benefited the strategy and the Dogs of the Dow ended up generating a slight positive total return of .02% for 2018. This compares to a loss of 3.74% for the SPDR Dow Jones Industrial Average ETF (DIA) and a loss of 4.56% for the SPDR S&P 500 Index ETF (SPY) as displayed in the below table.

Data File (xls)

Both Merck (MRK) and Pfizer (PFE) were the top performing Dow Dogs and the top performing stocks in the broader Dow Jones Industrial Average Index for 2018 as well.

As the new year begins, one new member joins the Dogs of the Dow for 2019. Entering the Dow Dogs in the coming year is JP Morgan (JPM) with a dividend yield of 3.28%. Dropping out of the Dogs is General Electric (GE) not only because of its lower yield, but GE was removed from the Dow Jones Index last year.

Long MRK, VZ, JPM

Stock Buybacks Up 57.8% In Third Quarter

S&P Dow Jones Indices recently reported preliminary dividend and buyback information for the third quarter ending 9/30/2018. On a year over year basis stock buybacks for S&P 500 companies are collectively up 57.8% for Q3 2018. For the 12-months ending 9/30/2018 total buybacks increased 39.1%. Relative to buybacks, dividends increased a much smaller 9.7% resulting in combined dividends plus buybacks increasing by 36.2% for the third quarter. Year over year operating earnings were reported up 25.8%.

The three largest buybacks were initiated by companies in the information technology sector:

• Qualcomm (QCOM): $21.2 billion
• Apple (AAPL): $19.4 billion
• Oracle (ORCL): $10.3 billion

For the quarter the top 20 companies initiating buybacks in the quarter accounted for more than half, or 54.3%, of the total buybacks of all S&P 500 firms.

In conclusion, I would prefer to see larger dividend increases which would be more of an indication that companies expect to see improved cash flow/earnings over an extended time frame. The recent tax cut is not permanent though; thus firms are likely hesitant to commit to higher dividend payments on an ongoing basis. The most significant tax cut expiration impacting businesses might be the phase out of the full expensing of equipment purchases beginning at the end of 2022. At the moment though, companies seem committed to returning to shareholders some of the cash flow benefits resulting from the tax cut.

With Abysmal Investor Sentiment A Market Bottom Might Be Near

Simply noting that the S&P 500 Index is down 12.45% month to date through the close on 12/21/2018, this pretty much sums up the damage inflicted on investors by the market. After a strong start to the year, and following a rewarding 2017, the S&P 500 index had a return of 9.62% through late September. In nearly three short months thereafter, the S&P 500 Index has declined 19.23% from its high, leaving the index down 9.61% for the year through 12/21/2018. This type of market reversal has resulted in investor sentiment turning extremely bearish.

The equity only put call ratio reached 1.13 at Friday's close. Readings above 1.0 represent an extreme bearish reading. The equity market has a tendency to reverse itself when the P/C ratio is above 1.0.

Trading volume on Friday reached a high level last seen in the market pullback in 2011. This high volume level on a down day in the market could signal a capitulation trading day. These capitulation days do not necessarily wash out on a single day; however, it is a sign a market bottom might be near.

The Fear & Greed Index reported by CNN Business is about as low as it can get at '3'. All seven of the components that comprise the Fear/Greed Index calculation are at extreme fear levels.

The NAAIM Exposure Index was reported at 31.96% this week. The NAAIM Exposure Index consists of a weekly survey of NAAIM member firms who are active money managers and provide a number which represents their overall equity exposure at the market close on a specific day of the week, currently Wednesday. Responses are tallied and averaged to provide the average long (or short) position or all NAAIM managers as a group. Institutional money managers have equity allocations at a level approaching those reached during the market pullback experienced in 2015.

Lastly, as this is written, it appears a government shutdown will take place. Charles Schwab notes prior government shutdowns have not had a long lasting negative impact on equity markets as seen below.

This year has been difficult for investors long the market. In a research report I received today it was noted that of 102 Morningstar fund categories, only short term bonds/loans, municipals and one economic sector – utilities – have positive returns this year. We believe recent market action is a correction in a longer-term bull market and continued strong fundamental data will result in a recovery and resumption of this long-term trend, all else being equal, but not without continued market volatility.

Trend In Index Earnings More Important Then A Slowing Rate Of Earnings Growth

One issue strategists are highlighting of late is the fact the earnings growth rate for the S&P 500 Index in 2019 is expected to decelerate from the mid to high 20+% level this year to the mid single digit percentage level in 2019. Some have indicated this slowing earnings growth rate may negatively impact U.S. equity returns next year. Of course the strong rate of earnings growth this year is due in part to the benefit companies have received from the tax cut. In addition to the tax cut benefit though, companies are seeing top line revenue growth in the high single digit percentage level. Although earnings will remain at a higher level due to the lower tax rate, the year over year growth rate in earnings will fall back to a more normalized level next year as the earlier year comparison is a higher number.

Continue reading >>>

Steep Decline In Bullish Investor Sentiment

The American Association of Individual Investors reported sentiment data for the week ending December 12, 2018. The sentiment survey reported the largest change in the difference between bullish and bearish sentiment since April 11, 2013. The swing in the current week equaled -35.4 percentage points.

Continue reading >>>

Tight Labor Market A Headwind For Business Sentiment

Although the November NFIB Small Business Optimism Index remains at a high level of 104.8, today's report is the third consecutive decline in the optimism index. The index high of 108.8 was reached in August of this year.

Continue reading >>>

Investment Fund Outflows Dominate

The most recent flow data for ETF's and mutual funds reported by ICI last week notes outflows occurred in nearly all of the broad asset categories. One exception was a small positive flow into commodity oriented investments.

 Source: ICI

Continue reading >>>

Trying To Make Sense Of China/US Trade Issues

What seems to be influencing the market the most at the moment is the trade issues with China and the U.S. Jeff Miller who writes at the Dash of Insight blog published a short article yesterday that seems to get to some of the main issues surrounding trade and the equity markets. A couple of highlights from the article follow, but the entire post is a worthwhile read. Jeff notes the market's reaction is,

"a typical example of the trading community’s failure to understand politics, negotiation, and compromise. I have highlighted this before on issues like Greece and the asserted collapse of Europe and concerning various US policy debates."

He notes further,

Here is what to expect:

• Decades of history will not be reversed in a few months. Be happy for some progress.

• The outcome will be a compromise. It will not be a complete success for either side, but each will trumpet what they have accomplished.

• Nothing big will happen until the last minute. This is the way that partisans demonstrate they have accomplished as much as possible.

• Eventual relief on the most important reciprocal tariffs.

• Some progress on the intellectual property issues.

• Some immediate relief on existing boycotts, e.g. soybeans.

The entire post can be read here: China/US Trade – Finding a Signal Amidst the Noise

GM Restructuring News Not A Sign Of A Slowing Economy

Today General Motors (GM) announced a restructuring that will cut 14,000 positions and the possibility of closing five auto manufacturing plants. Some headlines attributed the restructuring to an economy that may be slowing. However, when one reviews the data that comprise new sales of automobiles and light trucks, the exact opposite conclusion is drawn. A divergence has developed in the sale of cars versus light trucks that is clearly evident when one looks at unit sales volume in the below chart. Since 2014 a noticeable turn in interest has occurred toward the light truck category and away from the automobile category. In other words, it appears GM is responding to market forces and focusing the future of the company on the light truck market.

Continue reading >>>

Low Level Of Bullishness Means Equity Market Bottom Maybe Near

Investor sentiment continues a trend of turning less bullish. Today's Sentiment Survey report from the American Association of Individual Investors noted individual investor bullish sentiment decline 9.8 percentage points to 25.3%. Neutral sentiment declined 1.3 percentage points with the result that bearish sentiment rose 11.2 percentage points. The net result is the bull/bear spread of -21.8 pp is the widest since the spread reached -29 pp in February 2016.

Continue reading >>>

Institutional And Individual Investors More Bearish On Equities

At the end of October the American Association of Individual Investors reported individual investor bullish sentiment was 28.0%, one standard deviation below the bullishness average. Sentiment measures are contrarian ones and are most actionable at their extremes. October's reading was certainly not an extreme level; however, the reading was at a low level of bullishness for the individual investor sentiment measure. Since the January market high, the bullishness reading has vacillated between +26% to +45%, with a level in the mid teens being an extreme.  Today's reading of 35.1% bullishness falls within this range, as does the 36.2% 8-period moving average.

Continue reading >>>