Reverse effect of the Dogs of the Dow technique for the S&P 500 Sectors

We all heard of the famous Dogs of the Dow investing technique. This investment philosophy sorts the stocks in the Dow Jones 30 Index by Dividend Yield on the last day of the year. Then an investor takes the top ten stocks with the highest dividend yield and holds them for the entire year, until the next rebalancing point, at the end of the next year.

According to the Dogs of the Dow website, the strategy seems to have outperformed the S&P 500 Index, for the past five years.

Investment				2006	2007	2008	2009	2010	CAGR
Dogs of the Dow				30.3%	2.2%	-38.8%	16.9%	20.5%	2.8%
S&P 500				15.8%	5.5%	-37.0%	26.5%	15.1%	2.3%

Source: www.dogsofthedow.com

I wanted to see if a similar result could be applied to the S&P 500 sectors, as represented by XLB, XLE, XLF, XLI, XLK, XLP, XLU, XLV, XLY ETFs. I came up with a very different results.

In fact, my analysis shows that if you would have invested into lowest yielding sector, for the same time period, you would be way ahead of the game, more specifically you would comfortably outperform the S&P 500 Index.

I first calculated historical sector dividend yields.

Yield		2006	2007	2008	2009	2010
XLB		3.4%	2.2%	4.1%	1.9%	1.7%
XLE		1.3%	1.1%	2.1%	1.9%	1.6%
XLF		3.3%	4.5%	7.6%	1.3%	1.1%
XLI		2.0%	1.9%	3.5%	2.5%	1.9%
XLK		1.1%	1.1%	2.1%	1.5%	1.4%
XLP		2.4%	2.4%	3.2%	3.0%	2.8%
XLU		3.9%	3.3%	5.0%	4.5%	4.4%
XLV		1.9%	1.9%	2.8%	2.1%	2.1%
XLY		1.0%	1.3%	2.2%	1.4%	1.4%

Source: Select Sector SPDRs, AltaVista, The Rockledge Group

I ran a simple backtest performance calculation by taking the top yielding sector at the end of every year. Then I added the second highest yielding sector to the portfolio, then I added the third highest yielding sector the portfolio, and so on. Here are the annual returns, as well as the Cumulative Annual Growth Rate.

Returns			2006	2007	2008	2009	2010	CAGR
Highest yielding sector			19.8%	-19.2%	-54.9%	11.7%	4.4%	-12.6%
2 highest yielding sectors			18.5%	-0.4%	-41.9%	13.0%	8.8%	-3.4%
3 highest yielding sectors			18.3%	4.0%	-42.8%	16.0%	6.9%	-2.7%
…			17.2%	8.5%	-42.0%	16.9%	12.0%	-0.7%
…			16.3%	9.5%	-36.7%	17.9%	13.7%	1.5%
…			14.7%	9.1%	-34.6%	22.9%	14.9%	3.0%
3 lowest yielding sectors			15.1%	5.8%	-34.4%	27.0%	14.4%	3.0%
2 lowest yielding sectors			14.6%	9.7%	-35.3%	28.7%	16.0%	4.0%
Lowest yielding sector			15.0%	10.4%	-35.8%	27.4%	15.5%	3.7%
SPY			15.2%	5.1%	-36.8%	26.4%	14.6%	2.1%

Source: The Rockledge Group

I think the results are quite fascinating. So investing into the highest yielding sector every year would give you the worst possible result of negative cumulative annualized growth rate of -12.6% vs. SPY return of +2.1%. Next, by adding the second highest yielding sector to the portfolio at the end of every year would bring you negative -3.4%. And so on.

On the other hand, if I would have invested every year into the lowest yielding sector, I would earn +3.7% vs. SPY return of +2.1%. Next, if I add a second lowest yielding sector at the end of every year I would earn +4.0%. If I continue to add the lowest yielding sector to the portfolio I can still do quite well, beating SPY with up to four lowest yielding sectors. It’s at the midpoint of adding the fifth sector, where my returns would lag SPY.

I am not a big fan of passive investing, which this is, but if you are looking to make an investment decisions only once a year and then go sailing around the world for the rest of the year, till the next rebalancing point, this straightforward analysis is something to consider.

 

Position disclaimer: I and client portfolios hold long and short positions in XLE, XLF,  XLU, XLV and XLY .