Buy the Dow
In my last post about various dogs of the Dow strategies, I outlined the potential for market beating stock picks through the identification of depressed Dow stocks. The general idea is that this forced contrarian strategy is a good way to induce all too often over optimistic investors to truly buy low and, hopefully, sell high.
These efficacy of various Dow underdog strategies is hard to prove over a long period of time. But, the idea that the Dow offers a risk averse entry to the stock market.
As you can see, the Dow Jones Industrial Average since 1950 has provided a .3% lower annualized return than the S&P 500 over the last half century with 9% less volatility and lower downside deviation. (You can learn to calculate these metrics in my post series on Portfolio Performance Metrics.) So, while the Dow Jones has underperformed the S&P over the last 50 years, it has provided a modicum of “safety” for those looking for less volatile year-to-year price movements.
But, why should you buy the Dow today? First and foremost, the Dow Jones’ indicated dividend yield is currently almost 4.0% whereas the S&P 500 offers just 3.3%. This provides some level of cushion as you wait for the markets to turn around. More importantly, if history can be our guide, you won’t have to wait long for an eventual rebound.
Since 1928, the Dow Jones has posted just 28 down years with 5 sets of sequential down years. Implying that, over the last 80 years, there have only been 19 year plus periods in which the market destroyed value. 65% of 80 years provided positive return. And, more importantly, years following a >20% decline averaged a 26.1% rebound. Not enough for those who bought before a decline to be made whole, but a very intriguing possibility for those of us with capital after a major market disjunction. (Data from Data360.org)
For more on the bull case for the Dow, check out this analysis provided by Ned Davis Research. This shows a renormalization of price dividend ratios which has been shown to be the best long term predictor of overall market performance. While we may still seem to be “overvalued” based on this metric, remember that shareholder returns have shifted towards share buybacks over dividends in the last decade which has inflated price dividend ratios. Furthermore, realize that indicators rarely trade without hesitation from overvalued to undervalued. While there is a case to be made that the Dow may stay rangebound for years as dividends catch up to pricing and bring us back within historical valuation levels, intermediate rallies are very likely. For those with a longer term outlook, increasing dividends will only improve yield on cost (though current valuations do not necessarily scream “value”).
If this article has piqued your interest, you can trade the Dow Jones Industrial index using ETFs such as iShares Dow Jones US Industrials (IYJ), Dow Diamonds (DIA), and the Ultra Dow (DDM, provides 2x exposure). There’s even a Dogs of the Dow ETN which unfortunately debuted just over a year ago (DOD).
Full Disclosure: No positions in the stocks mentioned at the time of writing.
If you enjoyed this post, please consider to leave a comment or subscribe to the feed and get future articles delivered to your feed reader.
