The Dow Jones Industrials (^DJI 0.41%) have gotten off to a horrendous start to 2016. In just six weeks, the Dow has posted declines of more than 8%, and many think that a long-delayed bear market might finally be coming after seven years of strong performance. Yet one simple strategy has managed to avoid the bulk of the stock market's losses even though it has invested solely in Dow stocks. Let's take a closer look at why the Dogs of the Dow are doing so much better than the overall stock market and whether following the strategy will point you to crash-resistant Dow stocks.
How the Dogs of the Dow are faring in 2016
The idea behind the Dogs of the Dow is simple. At the beginning of the year, pick the 10 stocks that have the highest dividend yields, and then hold onto them all year.
So far in 2016, the Dogs of the Dow are doing a lot better than the overall market. As of Feb. 12, the Dogs of the Dow were down an average of 2.6%, or less than a third of the decline of the Dow Industrials.
The outperformance stems largely from three factors. First, the defensive posture of the market has favored stocks that have a reputation for doing well in market downturns, and that has favored the retail and consumer goods sectors. The Dogs have a disproportionate weighting toward those stocks, and so as a group, it has gotten support from the strength in the sector to a greater extent than the Dow overall.
In addition to the defensive tenor of the market, value-investing opportunities have also come into vogue. That has helped limit losses to oil stocks in the Dow despite the fact that crude prices have continued to plunge in 2016. Similarly, perceived value in the telecom industry has helped support shares of Verizon (VZ 0.78%), which is the leading performer in the Dow to date this year.
Finally, the Dogs of the Dow have been fortunate to avoid some of the terrible news that have hit other companies. For instance, Boeing's news of being investigated by the Securities and Exchange Commission has helped worsen its losses for the year to nearly 25%, but it isn't among the Dogs and therefore didn't hurt the smaller group's returns.
The Dogs still have risk
That said, investors still need to be aware of the risks involved with the Dogs of the Dow. The strategy is not bearproof, as the Dogs lost more than 40% in 2008 due largely to their extensive holdings of bank stocks and other companies hit hard by the financial crisis.
Even now, there are plenty of stocks among the 10 Dogs that face big challenges. Caterpillar (CAT -1.11%), for instance, has fallen 7% so far in 2016 because of continued difficulties in just about all of its core markets. The mining sector has started to show some signs of life, and gold prices above $1,200 per ounce point to the potential for a long-term rebound in the area that could help bring on an upward turn in the business cycle for the resources industry and lead to greater purchases of Caterpillar equipment. Nevertheless, ongoing energy weakness and global macroeconomic headwinds that have stifled construction and infrastructure activity could keep weighing on Caterpillar's returns well into 2016.
Similarly, other problems could hit the Dow Dogs. The pharmaceutical industry is well represented among the Dogs, and the political climate is extremely unfavorable to drug manufacturers right now. The outcome of the 2016 elections could have a dramatic impact on their full-year returns and their prospects going forward.
The Dogs of the Dow uses principles of value and dividend investing that give the strategy a somewhat defensive posture that can hold up well in market downturns. The Dogs won't necessarily save you from the next bear market, so it's important not to see the strategy as being safe from losses. Given the performance of its constituents so far, however, using the Dogs strategy might cushion the blow if the stock market remains weak throughout 2016.