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Another Winning Quarter

Equity markets have grappled their way up the proverbial wall so far in 2012, with the major U.S. stock indexes sporting respectable gains for the year through September. This was accomplished against a backdrop of elevated unemployment and anemic economic growth on the home front, along with the country’s worst drought in half a century. Adding to investors’ worries were an ongoing debt crisis and spreading recessions in Europe, and concerns that China’s growth engine may be slowing.

To be sure, it hasn’t all been bad news on the economic front. For one thing, the key housing market appears to be showing increasing signs that the worst is finally behind it. Also, unemployment took an unexpected dip in August, though some will argue that a good portion was due to fewer people looking for work, and thus no longer technically unemployed.

But the most tangible support for stock prices has likely come about from the latest central bank efforts to stem the negative economic tide. On our shores, the Federal Reserve Bank has launched the third round of quantitative easing (or QE3), with promises to keep interest rates low through 2015. Meanwhile, its counterparts in Europe stand at the ready to buy as many bonds as necessary to help keep the EU afloat. Further east, China has also been pumping billions into its own banking system.

As the saying goes on Wall Street, you can’t argue with the Fed. That is to say, when easy money policies are put in place (or extended) the rising tide is likely to lift all boats. That proved to be true in our little investment corner of the world, as the Dogs of the Dow posted a 3.9% increase in market value for the third quarter. This came in just a hair shy of the 4.0% gain achieved by the Dow 30 Industrials as a whole.

Top Dogs

Those who have been following along this year might be surprised to find Procter & Gamble (PG Free P&G Stock Report) standing squarely in the winner’s circle for the September quarter. The stock had been a laggard among the Dogs for the better part of the year, but has somewhat come into its own in recent months, posting an impressive 13.2% advance for the period. A fair portion of this can be attributed to investor approval of consensus-beating fourth-quarter results, the announced plans to buy back $4 billion of its shares in fiscal 2013, and the $10 billion restructuring initiative the company has underway.

Placing second for the quarter was General Electric (GE - Free GE Stock Report), whose stock showed a respectable gain of 9.0%. GE has been notably benefiting from the transportation and energy sectors. Regarding the latter, the company plans to break up its energy business into three stand-alone units later this year. The energy arm, which has become the company’s largest industrial unit (with roughly $50 billion in annual revenues expected for 2012) will be divided into GE Power and Water, GE Oil and Gas, and GE Energy Management.

Rounding out the top performers were the two health issues Pfizer (PFE - Free Pfizer Stock Report) and Merck & Co. (MRK - Free Merck Stock Report), both generating 8% in price increases. Pfizer, the world’s largest drug maker also reported better than expected June-quarter earnings. Although revenue comparisons have been off for the past three quarters (due to ongoing generic pressure as its Lipitor patent expired last November), effective cost discipline and increased contributions from emerging markets should help fuel steady profit growth for the company in the quarters ahead.

Unquestionably, the biggest drag on the Dogs performance this time around was the double-digit decline in the shares of chipmaker Intel (INTC - Free Intel Stock Report), which got a 15% clipping in the quarter. Management announced that third-quarter revenues would likely come in below its previous expectations due to weaker demand in its Personal Computer unit. Specifically, in response to the challenging economic conditions, customers throughout the distribution channel have been trimming inventories, and emerging market demand has slowed.

One Dog Leaves The Pack

It isn’t often that changes are made to the makeup of the Dow 30 Industrials. Indeed, there have only been 48 switches made over its 116 year history. The last one occurred in June 2009, when, in the wake of the financial crisis, General Motors (GM) and Citigroup (C) were swapped out for The Travelers Companies (TRV - Free Travelers Stock Report) and Cisco Systems (CSCO - Free Cisco Stock Report).

This time around Kraft Foods has been taken off the list. The food processing giant spun off its North American grocery business on October 1st into a new entity named Kraft Foods Group (KRFT). The remainder of the company, consisting of the international snacks business, was renamed Mondelez International (MDLZ). Stockholders received one share of KRFT common for every three shares of MDLZ common. Kraft was then replaced in the Dow by health insurer UnitedHealth Group (UNH – Free UnitedHealth Stock Report).

(Note: As the Dogs of the Dow is largely a buy-and-hold strategy, we’re now following the results of MDLZ and KRFT in the portfolio.)

Should UnitedHealth have a respectable yield at the end of 2012, it would certainly be a candidate for next year’s Dogs. But we wouldn’t exactly count on it, for at last check it generated a modest 1.5% payout. (By comparison, the 2012 Dogs currently have an average yield of around 3.3%, a full 100 basis points higher than the 20 remaining Dow stocks, which yield about 2.3%.)

The Year-To-Date Scorecard

After falling behind early in the year, the Dogs have mostly been playing catch-up. In fact, it wasn’t much of a contest until July, when they edged ahead of an equally weighted investment in all 30 Dow stocks. The mutts lost some ground over the last two months and for the third quarter as a whole, but they’re still putting in a good show, overall. For the nine months through September, the Dogs are up 12.3% in price, compared to a 12.5% gain for the Industrials as a whole. However, factoring in the aforementioned percentage-point yield advantage, the Dogs are maintaining their lead in terms of total return.

On an individual basis, General Electric has taken over the top spot, rising 26.8% year to date. The former leader AT&T (T Free AT&T Stock Report) is close behind with a gain of 24.7%, and third place remains firmly in the hands of Merck & Co., which had a healthy advance of 19.6% for the nine months.

Overall, if past is prologue, stimulative actions from the Fed and its overseas counterparts should provide a favorable backdrop for stocks in general, allowing them to maintain decent gains for the year and possibly add to their advance in the closing months of 2012. This, in turn, augurs well for the Dogs’ chances of recording good results for the year as a whole.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.