Investors who came into 2015 planning to reuse their 2014 playbook were given a rude shock on Friday as the surprising jobs report combined with the strong performance by crude throughout the week to suck all the momentum out of the “hunt for yield” trade with the Utilities Select Sector SPDR (XLU) dropping 4.12% while the iShares U.S Real Estate Fund (IYR) lost 2.64%.
You can imagine our little surprise when we checked our ETFG Quant Movers report and discovered that two small funds who focused on dividend payers and the classic “Dogs of the Dow” methodology saw big gains in their overall quant score and strong performance for the week to boot. The first is the ALPS Sector Dividend Dogs ETF (SDOG) while the second is the Elements Dogs of the Dow ETN (DOD) up .74% and .72% respectively in 2015 while the DJIA is up .01% and the S&P 500 continues to lag at -.17%. That kind of performance has us asking ourselves, can old dogs still bite?
2014 may have been the year for dividend payers, it certainly wasn’t a stellar year for the classic investment theory that advises determining ten highest yielding components of Dow Jones Industrial Average on December 31st and holding an equally weighted portfolio of those stocks with the expectation that they will outperform in the coming year. While there’s a lot of be said for simplicity, the Dogs of the Dow underperformed noticeably in 2014 with the ten highest yielding stocks of 2013 delivering a respectable 2014 performance of 7% compared to 10% for the DJIA ex the Dogs according to Dogs of the Dow.com. Then again, the Dogs didn’t include any of last year’s high flying sectors like utilities or REIT’s but was dominated by telecom stocks, energy giants, consumer staples, tech stocks and believe it or not, the odd industrial. Strong performance in 2014 by Microsoft, Intel and Cisco led then to escape the doggy doldrums but after checking our notes, what made last year so interesting for the Dogs was that the strongest performers weren’t necessarily offering the highest yields.
Momentum, one of the most persistent violations of the efficient market hypothesis, plays a role in much of our research and strong momentum played a key role in helping some of the Dow dogs escape the kennel in 2014. 2 of the 3 tech stocks that escaped from the dogs by outperforming the DJIA in 2014, Microsoft and Intel, had previously outperformed it in 2013. The other Dow tech stock, Cisco, had underperformed the DJIA by nearly 1,000 bps in 2013 but historically the stock has much higher volatility relative to most of the Dow components and was only in the dog house for one year. What really kept the high yielders from outperforming in 2014 was the fact that many of them had underperformed in 2013. GE may have been the worst performing Dog in 2014 but most of the underperformance for the group as a whole came from components that had been underperforming the benchmark for extended periods such as Verizon and AT&T which underperformed in 2013 as well as McDonalds and new addition Chevron, both of which had underperformed in 2012, 2013 and 2014.
If you were to look at those Dow stocks that were in the index in both 2013 and 2014, the chances of an underperformer in 2013 continuing to underperform in 2014 reached a post-Lehman extreme last year. According to the Yinzer Analyst, of the 27 stocks that were in the Dow for all of 2013 and 2014, 12 underperformed the benchmark in 2013 and 9 or those underperformed again in 2014 so 75% of 2013’s underperformers did so again in 2014, a post-Lehman extreme. Of the 15 Dow components that outperformed in 2013, 11 outperformed again in 2014, meaning 73% of the Dow outperformers in 2013 kept outperforming in 2014. Strong momentum, and not the quest for yield, is what separated the winners from the losers in 2014 and so far, the story hasn’t changed much in 2015 although the names certainly have.
At the end of 2014, the DJIA was yielding 2.58% and of the 15 stocks with higher yields, 10 are underperforming the broader index while McDonalds is only slightly ahead, up .3% this year while only 5 of the lower yielding Dow components are underperforming, led principally by financials J.P. Morgan and Goldman Sachs. The strongest performance has come from some of the lowest yielding components including Boeing and Disney and while the strong performance last week by energy stocks including Chevron (6.91%) and Exxon Mobil (5.45%) did much to lift DOD and SDOG, the real boost came from telecom giants Verizon and AT&T followed by Pfizer on the back of “merger mania.” Pfizer soared after announcing plans to acquire Hospira while funds from Verizon’s asset sales while be spent partly on share buybacks as well as freeing up capital for the next round of spectrum auctions or potentially buying Dish Networks and dragging sister telecom AT&T along for the ride.
What do Verizon, AT&T, and Pfizer have in common with Exxon Mobil, Chevron and McDonalds? They have all been persistent underperformers in the Dow while stalwarts like recent additions Goldman Sachs and Nike along with longer-term members J.P. Morgan and Johnson & Johnson are underperforming while low versus high yields seem to be playing little part in determining who out or underperforms the benchmark. Mean reversion seems to be playing a stronger part as consistent underperformers, whatever their 2014 yield, finally begin to catch up as investors start to look for relative bargains among domestic equities and along the lines of the broader trend that has seen less globally dependent (and 2014 laggards) mid and small cap names outperform in 2015.
While the Dogs of the Dow may be easy to remember, investors will need to dig deeper under the surface to find the truth behind 2015’s outperformance.
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