Weekly Market Commentary - Dog Days for the Dow

As the dog days of summer draw to a close during the coming weeks, seeking yield with strategies like the “dogs of the Dow” may no longer be rewarding. The Federal Reserve (Fed) meeting at the end of the month may change the markets’ theme.

In general, we believe investors can prepare by seeking out more cyclical securities stocks in August that may we believe offer more potential for price appreciation in the months ahead.

 

 

 

 

Dog Days for the Dow

The “dogs of the Dow” have best handled the heat of the dog days of summer.

The so-called “dogs of the Dow” strategy entails owning the highest dividend-yielding stocks in the Dow Jones Industrial Average (DJIA). Yield has been a rewarding theme in the markets this summer. In general, it has been the highest-yielding stocks and bonds that have outperformed their peers. For example, since the beginning of June in the bond market High-Yield Bonds have trounced the returns on High-Grade Corporate or Government Bonds, according to Barclays Index data. And in the stock market, the highest-yielding sectors have outperformed. Over the past three months, the high dividend-yielding Telecommunications Services, Consumer Staples, and Utilities sectors the of the S&P 500 have been outperformers. Specifically, the 10 dogs of the Dow stocks this year, led by strong performance among the Telecom carriers that are the highest-yielding stocks, have outperformed the DJIA during the summer months by over three percentage points.

But as the dog days of summer draw to a close during the coming weeks, yield may no longer be the overriding market theme. The Fed’s conference in Jackson Hole, WY is coming up on August 30-September 1. The Fed may use this opportunity to communicate its intention to pursue a third round of quantitative easing (so-called QE3), likely involving the purchase of Treasuries, Agencies, and Mortgage-Backed Bonds.

Counter-intuitively, a look back at prior rounds of Fed bond purchases shows that Treasury yields actually increased following the start of bond purchases. In each of the three prior bond purchase programs—QE1, QE2, and Operation Twist—the yield on the 10-year Treasury increased almost immediately, as you can see in Figure 1. This is because markets are forward-looking, and investors quickly anticipated the beneficial impacts of the Fed’s bond buying on the economy. As yields rise, investors shed more defensive, yield-oriented investments in favor of those with more potential for price appreciation.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

During the summer months so far, the most likely beneficiaries of another round of quantitative easing by the Fed have not reflected an increasing likelihood of Fed action. This can be seen in yield-oriented stocks leading rather than lagging the market, bond yields not rising, the dollar not falling, and gold not posting gains typically seen when the market expects a new bond buying program from the Fed.

The dog days originally were the sultry days when Sirius, known as the dog star, rose just before or at the same time as sunrise. The stars may no longer line up for dog stock investors as the calendar turns to September. In general, we believe investors can prepare by seeking out more cyclical stockssecurities, such as those in the Information Technology and Industrials sectors, in August that we believemay offer more potential for price appreciation in the months ahead.

 

 

IMPORTANT DISCLOSURES

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.

Names of securities mentioned herein are for informational purposes only and should not be considered investment advice or guidance, offer or solicitation, offer to buy or sell securities, nor a recommendation or endorsement by LPL Financial of the security or investment strategy. LPL Financial does not endorse or evaluate individual equities.

Dividend paying stock payments are not guaranteed. The amount of a dividend payment, if any, can vary over time and issuers may reduce dividends paid on securities in the event of a recession or adverse event affecting a specific industry or issuer.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price.

Quantitative Easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

Operation Twist is the name given to a Federal Reserve monetary policy operation that involves the purchase and sale of bonds. "Operation Twist" describes a monetary process where the Fed buys and sells short-term and long-term bonds depending on their objective.

Dow Jones Industrial Average (DJIA): The Dow Jones Industrial Average Index is comprised of U.S.-listed stocks of companies that produce other (non-transportation and non-utility) goods and services. The Dow Jones Industrial Averages are maintained by editors of The Wall Street Journal. While the stock selection process is somewhat subjective, a stock typically is added only if the company has an excellent reputation, demonstrates sustained growth, is of interest to a large number of investors and accurately represents the market sectors covered by the average. The Dow Jones averages are unique in that they are price weighted; therefore their component weightings are affected only by changes in the stocks’ prices.

Consumer Staples Sector: Companies whose businesses are less sensitive to economic cycles. It includes manufacturers and distributors of food, beverages and tobacco, and producers of non-durable household goods and personal products. It also includes food and drug retailing companies.

Telecommunications Services Sector: Companies that provide communications services primarily through a fixed line, cellular, wireless, high bandwidth and/or fiber-optic cable network.

Utilities Sector: Companies considered electric, gas or water utilities, or companies that operate as independent producers and/or distributors of power.

Information Technology: Companies include those that primarily develop software in various fields such as the Internet, applications, systems and/or database management and companies that provide information technology consulting and services; technology hardware & Equipment, including manufacturers and distributors of communications equipment, computers and peripherals, electronic equipment and related instruments, and semiconductor equipment and products.

Industrials Sector: Companies whose businesses manufacture and distribute capital goods, including aerospace and defense, construction, engineering and building products, electrical equipment and industrial machinery. Provide commercial services and supplies, including printing, employment, environmental and office services. Provide transportation services, including airlines, couriers, marine, road and rail, and transportation infrastructure.

This research material has been prepared by LPL Financial.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial is not an affiliate of and makes no representation with respect to such entity.