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September Goes Out Like a Lamb

Among stock market aficionados, October retains a legendary reputation as being a bad month. Indeed, American author and humorist Mark Twain once noted “October: This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.”

While Mr. Twain no doubt has his tongue firmly in cheek when he set down those words, the Crash of 1929, with its immediate impact and ensuing depression, cast a shadow on stocks for many decades. And, in more-recent memory, the huge one-day drop in October 1987 wasn’t exactly a picnic either. But when monthly performance figures are tallied up, it’s actually September that holds the crown for having the worst historical returns, on average.

Fortunately, as was the case in 2012, the month was benign this year, with global stock market indexes showing gains across the board. After accounting for several changes in its makeup (which we’ll review in a minute), an equally weighted position in the Dow Jones Industrials would have been up 1.7%. The Dogs of the Dow (meaning those 10 Industrials stocks that started the year with the highest yields) didn’t do quite as well. In fact, they came out exactly where they were at the start of the month.

Rejiggering The Dow

As we noted last month, the Dow 30 Industrials underwent several changes in September. At the close of business on September 20th, Nike (NKE - Free Nike Stock Report) took Alcoa’s (AA) spot. Visa (V - Free Visa Stock Report) changed places with Hewlett-Packard (HPQ) and Goldman Sachs Group (GS - Free Goldman Sachs Stock Report) replaced Bank of America (BAC).

As far as the Dogs of the Dow go, we wanted to keep things as close to a “real world” level as possible. In the first place, although Hewlett-Packard left the Dow, we have kept it in the portfolio because, in essence, the Dogs is a buy-and-hold strategy.

For the sake of performance comparisons, we have assumed that an investor with a position in all the Dow Industrials would swap out of the stocks removed from the index and use the funds to buy as many shares of the new companies (on a like-for-like basis) as possible. The changes were all calculated based on the closing prices on September 20th.

Winners and Losers

Computer giant Hewlett-Packard once again took center stage in directing the fortunes of the Dogs last month. The stock had established a sizable lead over the pack (and all 30 Dow stocks, for that matter) through July. It closed that month with an 80.2% year-to-date gain, but the stock then shed 9.1% in August, followed with a 10.1% drop in September. This brought down its year-to-date figures to 47.3%. Certainly not too shabby, and still more than enough to keep it on top of the Dogs. But the stock was no longer the star of the Blue Chip index. (That title was passed to Boeing (BA - Free Boeing Stock Report), a “non-dog” Dow, which was up 55.9% at the end of September.)

Hewlett-Packard has continued to struggle for a number of reasons. For one, its product mix is heavily weighted towards businesses that are experiencing declining demand, such as traditional storage systems and personal computers, the latter reflecting increased consumer preference for tablets and smartphones. The company’s sales and earnings will likely be down in 2014, and a complete recovery will probably take several years. However, even with its impressive advance so far this year, the stock still holds wide upside potential over the long term.

HPQ’s fall was the main reason for the Dogs’ relatively weak showing for September. Helping to even the scales, however, was a 4.3% gain for Intel (INTC - Free Intel Stock Report) stock. Part of this likely reflected high hopes for the company’s newly elected CEO, Brian Krzanich. The chip maker has a huge opportunity to expand its presence in the tablet and smartphone markets, both of which continue to see burgeoning demand. Also helping was an advance of 3.4% in shares of DuPont (DD - Free DuPont Stock Report), as investors appeared to be looking ahead to a strong second half for the chemical company, driven by its agricultural business. General Electric (GE - Free General Electric Stock Report) also had a solid move up (3.2%), as it appears to be delivering on its ambitious cost-cutting initiatives.   

Heading For A Photo Finish?

Although they’ve faltered in recent months, the Dogs have put up a good show, overall, beating the Dow’s aggregate performance throughout most of the year. But, things have gotten very close of late.

Indeed, an equally dollar-weighted position in the 10 Dogs at the start of the year would have been up 17.4 percent for the nine months through September. Seven of the 10 issues sported double-digit gains for the period, led by Hewlett-Packard (47.3%), DuPont (30.2%), and Johnson & Johnson (JNJ - Free Johnson & Johnson Stock Report, 23.7%).

Meanwhile, a similarly distributed portfolio of all 30 Dow components (allowing for the aforementioned switches) would have also advanced 17.4 percent. Indeed, it isn’t until we go out to three decimal places that a leader emerges, with the Dogs’ eight-month streak ending by a mere two-thousandths of a percentage point (10.422% vs. 10.424%).

However, the Dogs have an ace up their collective sleeves for, as those more familiar with the strategy already know, these stocks came into the year with a yield advantage, which gives them a (modest) overall edge in terms of total returns. Notably, even after the share-price gains posted through September, the group retains a very respectable 3.6% average yield. By comparison, the remaining Dow stocks yield 2.2%, on average.

Looking slightly ahead, the top contenders for 2014’s Dogs of the Dow list are Chevron (CVX - Free Chevron Stock Report) with a yield of 3.4%, and Microsoft (MSFT - Free Microsoft Stock Report), recently yielding 3.3%. Both stand a good chance of knocking out Johnson & Johnson, currently the bottom-Dog on the totem pole in terms of yield (3.0%), thanks to its strong price advance this year.

Conclusion

The stock market’s performance during the final quarter will likely, in large part, reflect when and by how much the Federal Reserve makes good on its promise to ease back on its aggressive bond-buying program. Relative to historical measures, the Dogs, and stocks in general, have established a sizable enough cushion so far this year to withstand a typical correction, with a further margin of downside protection provided by the Dogs’ solid yields.

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