The Dogs Take A Breather

After last year’s solid sprint, which saw the Dogs of the Dow strategy return 30.3% before dividends, performance has been decidedly more mixed so far in 2014. In January, stocks had their worst month since August of last year, with few names making it through unscathed. The Dogs of the Dow (that is, the 10 highest-yielding Dow components at the start of the year) weathered the month’s downturn comparatively better, with an equal-weighted position in all ten stocks falling 3.3% in value, versus a 4.8% decline for a similar position in all 30 Industrials.

[As a quick refresher, this year’s Dogs of the Dow are: AT&T (T - Free AT&T Stock Report), Chevron (CVX - Free Chevron Stock Report), Cisco Systems (CSCO - Free Cisco Stock Report), General Electric (GE - Free GE Stock Report), Intel (INTC - Free Intel Stock Report), McDonald’s (MCD - Free McDonald's Stock Report), Merck & Co. (MRK - Free Merck Stock Report), Microsoft (MSFT - Free Microsoft Stock Report), Pfizer (PFE - Free Pfizer Stock Report), and Verizon (VZ- Free Verizon Stock Report).]

February brought some relief to investors, some of whom, perhaps, had begun to fear that the good times were over. A balanced holding of the entire Dow-30 composite showed a gain of 3.6% for the month. The Dogs didn’t fare quite so well, advancing a mere 1.6%. Looking at the year-to-date so far, the comparisons are more balanced, with the Dogs down 1.7%, versus 1.4% for the entire Dow. However, that narrow margin will likely be erased by the inherent yield advantage of the Dogs system. (The 10 stocks began the year with an average yield of 3.6%.)

Merck Makes Its Mark

Merck & Co. has taken the top spot among the Dogs (and the entire Dow, for that matter) so far this year.  Shares of the drug maker led with a 5.8% gain in January and again in February when they moved up another 7.6%, making for a 13.9% combined gain. With these advances, the stock is currently trading at its highest levels in more than five years. The market appears to have taken a more favorable view of the company after fourth-quarter results that marked its first year-over-year profit gain since September of 2012. To be sure, the company still has some challenges ahead. We still project sales to be materially lower in 2014 versus 2013, but comparisons should become easier as the year progresses. Moreover, we believe new product contributions and continued growth of existing franchises should be enough to reinforce stability over the long term.

The second spot among the Dogs is taken by fellow pharmaceutical giant, Pfizer, whose stock is up 4.8% for the year so far. It also reported favorable fourth-quarter results (after adjusting for nonrecurring items), thanks to increased cost cutting and a lower tax rate. We see several potential drivers that could signal a brighter outlook for Pfizer this year. We look for top-line comps to turn positive in the coming quarters, supported by solid momentum in its epilepsy drug, LYRICA, a healthy pipeline, and surging oncology business.

A Few Mutts Hold Back The Pack

While the Dogs can boast about having the best-performing Dow component among their group, they also hold the dubious distinction of counting the three-worst performing issues among their fold. Heading up this down-trodden trio is AT&T, whose shares were down 9.2% through February. The telecom company continued to show solid share-net growth in the December quarter, supported by stock buybacks, good cost management, wireless margin improvement, and increased penetration of U-verse, its broadband, video, and IP telephone service. However, this growth is being overshadowed, it seems, by some disappointing wireless subscriber trends. Specifically, AT&T’s wireless subscriber growth continues to lag that of many sector rivals. Nonetheless, we expect the numbers to get better gradually, as the company’s new early upgrade program gains traction.

General Electric came in second from the rear, with its stock shedding 9.1% two months into the year. Although its fourth-quarter results were right on target with Wall Street’s expectations, it appears that some view the company’s earnings as being propped up by cost trimming. The cuts are so sizable that skeptics view them as unsustainable. Our top- and bottom-line calls for 2014 are unchanged. We look for revenues of $149.8 billion and earnings of $1.75 a share. These equate to 3% and 7% annual growth, respectively.

Rounding out this list, we have Chevron, which has fallen 7.7%. The oil company’s suit with the Ecuadorean government (and the resulting $9.5 billion fine it was asked to pay) has certainly continued to weigh on the shares, and it could be a year or more before that issue is finally resolved. Meanwhile, fourth-quarter earnings came in lower than expected due to high E&P expenses and shrinking refining margins. Still, we look for the company to generate a mid-single-digit share-net advance in 2014, snapping a two-year downward trend.

Looking Ahead

As we opined back in January, investors should hardly expect a repeat performance of last year’s exceptional stock returns, and the results so far have borne out this thinking.  Specific to the Dogs, the aforementioned 1.7% loss so far compares quite poorly to the 10.2% gain that they were sporting this time last year. But the game of investing, it is often said, is more akin to a marathon, rather than a sprint, and we still have 10 more months to see how things pan out. Generally speaking, though, the outlook for equities remains favorable, based on our expectations of gradually strengthening GDP growth as the year progresses, and a likely continuation of accommodative policies on the part of the Fed.

Recent market indicators have lent some support to this view. Namely, job growth, new home sales, manufacturing, and retail sales all increased in February. Also, as of this writing, fully half of the 10 Dogs of the Dow stocks carry Above Average Timeliness ranks for year-ahead relative performance. 

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