The “dogs of the Dow” investment strategy for US stocks
Written by: Mutsumi Kagawa (Chief Global Strategist, Economic Research Institute of Rakuten Securities)
1. Concerns about US market facing an economic slowdown
US stocks fluctuated this week on speculation about tightening monetary policy and the outlook for the economy. Last week, the FRB (US Federal Reserve Board) and ECB (European Central Bank) hiked their rates by 0.5% as expected. On the other hand, both FRB Chair Powell and ECB President Christopher Lagarde announced a hawkish policy during the press conferences, stating that “continuous interest rate hikes are appropriate.” In addition, several macro indicators fell below market forecasts, raising concerns about an economic slowdown in Europe and US... Chart 1 shows the year-on-year growths of the leading economic indicators released by The Conference Board (private research agency) and the money supply (M2) released by the FRB. The growth of the leading economic index was -2.7% (October), which is already in negative territory and is indicating a slowdown in the economy. It was in negative territory immediately after the Covid-19 pandemic. But at that time, the FRB and the Department of the Treasury expanded monetary easing and fund supply. The money supply grew more than 20% in the second half of 2020, supporting the reversal recovery of the economy and stock prices. However, current money supply growth is subdued due to the effects of monetary tightening. Year-on-year growth in the CPI (Consumer Price Index), which indicates inflation trends, has slowed down for 5 consecutive months (November). The stock price adjustments in December seems to be indicating the financial authorities to “stop raising interest rates to aggressively.”
2. Pay attention to the “dogs of the Dow” investment strategy again
With stock prices falling on average in 2022, forecasted dividend yields for individual stocks have generally risen. In view of this, I would like to pay attention to the “Dogs of the Dow” investment strategy as an investment strategy for next year. “Dogs of the Dow” is a simple investment method introduced in the book “Beating the Dow” by a prominent US investor (Michael B. O’Higgins) in the 1990s. The steps are as follows: ① Select the top 10 stocks in descending order of “dividend yield” from the 30 stocks used in the Dow Jones Industrial Average (Dow Jones Industrial Average of 30 Stocks) at the end of the year. ② Invest equally in each of the 10 selected stocks and hold them for 1 year. ③ At the end of the year 1 year later, select the top 10 stocks with the highest dividend yields again from the Dow Jones Industrial Average stocks, and repeat the diversified investment with equal amount (rebalance). You can get relatively high-yield dividends from 10 stocks just by trading once a year at the end of the year or at the beginning of the year with this method.
Chart 2 compares the total earnings of the Dow Jones Industrial Average with the Dow Jones High Yield Select 10 Index TR, which shows the total earnings of 10 stocks selected by their high dividend yields. You can see that the group of stocks selected by the “dogs of the Dow” investment strategy outperformed the Dow average this year (as of December 21). Although such investment strategy may sound daunting, all you have to do is to select 10 stocks with high dividend yields from among outstanding stocks (stocks included in the Dow Jones Industrial Average), which are called “blue chips” in US, according to the “rule” (steps) every year. In fact, since it is a once-a-year trading, it is a realistic investment method that can reduce trading costs.
3. Preempting the “dogs of the Dow” stocks approaching the end of the year
Chart 3 is a list of 10 stocks selected in descending order of “dividend yield” from the Dow Jones Industrial Average (as of December 21) according to the above steps. Each “dividend yield” is calculated by “dividend forecast for the next fiscal year (average market forecast) ÷ latest stock price”. Among the stocks with relatively high dividend yields, there are many stocks which stock price lags significantly compared to the forecasted dividend. By selecting such stocks to build a portfolio, we can “diversify investment in US blue-chip stocks emphasizing on dividend yield”. Of course, the stock prices of individual stocks may fluctuate slightly by the end of the year. But the top 10 stocks shown in Chart 3 are not expected to change significantly. The environment surrounding stocks in 2023 is likely to continue with many uncertain factors such as recession concerns, Ukraine war and the intensification of the US-China conflict. While it is difficult to be confident to expect stock price rise, it is highly likely that “value investment that emphasizes on dividend yield” will continue to outperform in 2023 as in 2022. Therefore, I would like to pay attention to the “dogs of the Dow” investment strategy again.