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September Quarter

The broader market indexes, and particularly the Dow Jones Industrial Average, have set a multitude of new highs in 2014, as the bull market tries to extend its streak to six straight years.  However, the gains have not come without the occasional setback, and the overall advance has been significantly less than in recent years. Indeed, the Dow Industrials and the Dogs were comfortably in double-digit territory around this time in 2013, while this year both have so far been restrained to single digit gains. But on the plus side, monthly volatility has kept within a fairly narrow range, as well.

For the third quarter, having an equally weighted position in all 30 Dow components would have resulted in a gain of 1.9%.

Meanwhile, those following the Dogs of the Dow strategy (having invested in the top 10 highest yielding issues at the start of the year) would have been up 1.5%, while the 20 industrials excluded from the Dogs would have been up 2.1%.

Top Performers

Intel (INTC - Free Intel Stock Report) continued it winning ways, taking the crown for a second consecutive quarter with an advance of 12.7% for the September interim. A good part of that was likely driven by better-than-expected second-quarter results for the chip maker. Investors were also likely encouraged that the company looks to be on track to reach its goal of 40 million tablets sold, and the fact that its Baytrail SoC (system on a chip) is ramping up.

Taking the number-two spot was Microsoft (MSFT - Free Microsoft Stock Report), with a gain of 11.2%. Although its earnings for fiscal 2014 (ended June 30th) were down from the previous year, investors appear to be looking ahead to the software giant’s broad range of opportunities in the cloud and mobile computing markets.


On The Negative Side

While the Dogs only trailed the Dow as a whole by 40 basis points in the September quarter, it’s worth noting that five of the 10 stocks lost ground during the period. (By comparison, only 30% of the remaining Dow components were down.)

Shares of Chevron (CVX - Free Chevron Stock Report) slid 8.6%. However little blame can be placed on anything of the integrated oil company’s own doing. Indeed, its earnings for the June quarter were up 8% compared to the prior-year period, topping consensus estimates by a comfortable margin. More likely, the shares were reacting to the combination of a stronger dollar, rising production from U.S. shale fields, higher stockpiles, and slowing global demand growth, all of which conspired to push U.S. crude oil prices to a recent 17-month low.

Also occupying the dog house for the period was McDonald’s (MCD - Free McDonald’s Stock Report), whose shares declined 5.9%. The restaurateur’s second-quarter top- and bottom-line numbers were only slightly better than the prior year’s, and that was mostly due to expansion and price increases. Meanwhile, comparable-store sales were flat and guest traffic was negative in all regions. Moreover, food-quality issues in China will likely weigh on second-half results.


Heading Into The Final Period, The Mutts Hang On

The Dogs enjoyed their widest lead at the end of August, at which time they were edging out the aggregate year-to-date performance of the Industrials by 440 basis points. Since then, they’ve lost some ground. At the end of September, they were up 7.2% as a group, leading the Dow by 220 basis points (up 5%) and the non-Dogs by 320 basis points (up 4%)

The biggest contributors for the year so far were the aforementioned Intel (up 34.1%) and Microsoft (up 23.9%). The Dogs are also contending for a Canine Trifecta, of sorts, counting the three highest performing Industrials amongst their pack; the third being Merck & Co. (MRK - Free Merck Stock Report), up 18.4%. The drugmaker’s top line has been in decline for three years now, due to patent losses. However, the company has been able to stem the profit erosion through growth in its core franchises.

The solid returns from these three stocks have served to offset having four of their members in the red so far in 2014. These are General Electric (GE - Free GE Stock Report), -8.6%; Chevron, -4.5%; Pfizer (PFE - Free Pfizer Stock Report), -3.5%; and McDonald’s, -2.3%.

We’ve already touched upon the issues facing Chevron and McDonald’s. As for General Electric, the industrial conglomerate is going through a transitional period as it increases its strategic focus on infrastructure and technology. The company has already divested its media unit (NBC Universal, now part of Comcast (CMCSA)) and, with the partial IPO of Synchrony Financial (SYF), has taken the first step in exiting the consumer finance space. More recently, it agreed to sell its home appliance business to Sweden’s Electrolux AB (ELUXY) for $3.3 billion in cash.

Meanwhile, Pfizer, as we’ve pointed out throughout the year, has been hampered by intense generic competition on its branded product line. Similar to the case with Merck & Co., the drugmaker’s top line continues to edge downward, and management recently lowered its full-year GAAP earnings guidance to $1.47-$1.62, versus its previous estimate of $1.57-$1.72.


Conclusion

On the economic front, at least, equities should find support in more stable GDP growth for the second half, probably in the range of 3.0%-3.5%. Also, the Federal Reserve is likely to continue lending an assist. Although its aggressive bond-buying program is winding down, short term interest rates stand a good chance of remaining near historical lows, at least through the early part of the New Year. All in all (and occasional distractions from flare-ups overseas aside), stocks are likely to maintain their upward trend, albeit in relatively lackluster fashion.

Our proprietary Timeliness ranking system currently gives eight out of the 10 Dogs a rank of Average (3) or better for relative performance in the coming six to 12 months, so they appear to be well-positioned to hold onto their lead in the closing quarter. Should they do just that, it would make for two years in a row (and four of the last five) that the Dogs have come out on top.

For those looking to get a leg up (no pun intended) on next year’s Dogs, the current top contenders (in terms of recently having the highest yields among the Industrials) are AT&T (T - Free AT&T Stock Report), Verizon (VZ - Free Verizon Stock Report), Chevron, McDonald’s, Pfizer, General Electric, Procter & Gamble (PG - Free P&G Stock Report), Cisco (CSCO - Free Cisco Stock Report), Merck, and Caterpillar (CAT Free Caterpillar Stock Report). Readers should note, however, that this list could (and likely will) change before yearend, depending on price action. 

 

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