Market volatility has returned after years of gradual but steady advances, and the Dow Jones Industrial Average (DJINDICES: ^DJI) has finally gone through a 10% correction. Many conservative investors who had feared that stocks were long overdue for a downward move used defensive strategies like the Dogs of the Dow in the hopes of protecting themselves from the full brunt of a market correction.
Less than two months into the year, it's too early to pass final judgment on whether the Dogs of the Dow will outperform the broader average in 2018. But it's helpful to see how the strategy has fared during the turbulence that the Dow has experienced in February. Below, we'll look at what's working and what's not for the Dogs of the Dow this year.
Data source: Dogs of the Dow website.
How to invest in the Dogs of the Dow
Before explaining the relative performance of the strategy, it's important first to know what the Dogs of the Dow are. The strategy emphasizes stocks with strong dividend yields by sorting the 30 stocks in the Dow Jones Industrials at the beginning of the year by yield. The top 10 stocks in the average then become that year's list of Dow Dogs.
To follow the strategy, you buy equal dollar amounts of the 10 Dow Dog stocks and then hold onto them all year long. If you want to keep using the strategy going forward, you then resort the Dow 30 by dividend yield at the end of the year, replacing any stocks that fell off the list with their new counterparts.
Image source: Getty Images.
As 2018 began, the Dogs of the Dow were coming off a losing year in 2017, but they'd still posted better returns in six out of the past eight years. Investors hoped that the Dogs would be able to bounce back this year.
A tough start for the Dogs
Yet that hasn't yet been the case. The Dogs are still down for the year. By contrast, even though the Dow has given up most of its gains from early in 2018, it's still on the plus side. The 5-percentage-point difference is quite wide historically, especially so early in the year.
The underperformance in the Dogs of the Dow has come from a number of sources. Six out of the 10 stocks are down on the year, with two more near break-even. That compares to just seven out of the 20 non-Dog Dow stocks having lost ground.
The primary drag on the Dogs of the Dow has been the energy sector. Both of the average's major oil companies are down considerably, as crude oil prices have weakened after a strong end to 2017. In addition, industrial stocks that are closely tied to energy have also suffered from the sector's poor performance.
The fact that the Dow is price-weighted while the Dogs of the Dow are equal-weighted has also hurt relative performance. General Electric (NYSE: GE) has continued to lose ground in 2018, dropping another 14% so far this year after a terrible showing in 2017. In the Dow Jones Industrials, GE's loss has had almost no impact on the broader measure, because its stock price of $15 per share gives it only a 0.4% weighting. Among the Dogs, however, General Electric gets a full 10% weighting, and that has magnified the pain that its loss so far this year has caused. By contrast, non-Dog Boeing (NYSE: BA) has continued its ascent with a 20% rise so far in 2018, and its nearly 10% weighting within the Dow Jones Industrials has done a lot to lift the overall index early in the year.
Can the 2018 Dogs of the Dow bounce back?
The thing about value-based dividend strategies like the Dogs of the Dow is that it can take a lot longer than seven weeks for things to turn around. Even a year isn't that much time to mount a comeback, but the Dogs are full of past stories showing the favorable influence from turnarounds.
It's too early to tell if the Dogs are doomed to another year of underperformance, but some investors are disappointed that they didn't hold up better during the market's big moves recently. Conservative investors need to understand that the Dogs won't always behave like an anchor to dampen ups and downs, and the strategy will have to see a considerable reversal of fortune to make up for lost ground so far in 2018.
Dan Caplinger owns shares of Boeing. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.