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Dogs of the Dow Theory

Written By Brian Hicks

Posted December 16, 2008

In today’s market, today’s trading theories can be tossed out the window.

Theories such as…

  • The first half of the year tends to bring better returns than the second half.
  • That markets in the northern and southern hemispheres predictably succumb to the winter blues, or Seasonal Affective Disorder.

None of these theories are dying off as much as the "January Effect," or the "expected" time of year when tax-conscious investors sell stocks to write off losses against capital gains. In this theory, the "tax sell-off" would depress stock values lower until buyers came back in early January.

And, yes, for awhile it was a flourishing, profitable theory. Bullish January effect theorists will remind you that from 1925 to 1993, small cap stock outperformed large cap stocks in January in 69 of 81 years.

All you had to do was buy small cap stocks in mid-December and hold until the last day of January. It was like having a license to print money, as small caps, on average, returned 7% every January as compared to 2% for large caps.

But its time has come and gone as an ultra-reliable theory. Even as a small cap investor, I wouldn’t buy into it as a useable modern-day theory. Instead, I’d buy value among the small caps, ignoring the theory.

Since 1994, for example, it’s had off and on years. Comparing the Russell 2000 to the Dow, using the dates of December 1st to February 1st as my parameters, for example, I found that in:

  • 1994, the large caps stocks outperformed small caps
  • 1995, the large cap stocks outperformed small caps
  • 1996, the large cap stocks outperformed small caps
  • 1997, the large cap stocks outperformed small caps
  • 1998, the large cap stocks outperformed small caps
  • 1999, small cap stocks outperformed large caps
  • 2000, small cap stocks outperformed large caps
  • 2001, small cap stocks outperformed large caps
  • 2002, small cap stocks outperformed large caps
  • 2003, small cap stocks outperformed large caps
  • 2004, the large caps stocks outperformed small caps
  • 2005, the large caps stocks outperformed small caps
  • 2006, small cap stocks outperform large caps
  • 2007, the large caps stocks outperformed small caps

Instead, look for small-cap stocks that have historically weathered slowdowns, and have historically risen every January. Individual stock research such as this is stronger than buying baskets of small caps, hoping the volatile January effect theory pays off.

While the January effect has outlived its usefulness, here are two to bank on.

The New Year’s Resolution Theory

This is the time of year when we buy one beaten down diet stock and watch it jump around the time of year when Americans (about 90% of them, according to Johns Hopkins Medicine) make their New Year’s resolution to lose weight, diet, and exercise more, which usually ends in passing on the resolution until next year.

It’s a seasonal phenomenon that many of us are all too familiar with.

Simply find the stocks, namely ones like (DIET), that have historically risen at the tail end of the year on New Year’s resolutions… and buy at the beginning of November and sell in December.

While we haven’t noticed similar runs in stocks like Weight Watchers and Nutrisystem, we have seen it in (DIET).

  • From about mid December 2003 to the start of 2004, DIET ran from about $3.50 to about $6.50.
  • DIET ran from $3.25 to $5.35 from mid-December 2004 to the start of 2005.
  • It ran from $4.50 to about $8 between mid December 2005 and January 2006.
  • From mid December 2006 to the start of 2007, DIET sold off after an early November 2006 run.
  • From November 2007 to December, DIET ran from about $4.50 to $6 before selling off to $2 in the months that followed.
  • And when the editors of SC Trading Pit brought it to your attention here, you had the opportunity to buy at $3 before it ran to $4 just days later.

Dogs of the Dow Theory

While 2009 Dogs of the Dow haven’t been revealed just yet, you’d be wise to jump on this one. With the Dogs of the Dow theory, you’re simply buying a basket of beaten down stocks, and forgetting about them until December 31, 2009. That’s when you’ll sell… and buy the new round of Dogs of the Dow.

Because this theory has been spot on, you’re simply putting your faith in its reliability, which, according to reports, isn’t too shabby.

Dogs of the Dow Track Record:

  • In 1996, they were up 29%.
  • In 1997, they were up 22%.
  • In 1998, they ran up 11%
  • And in 1999, they ran up another 4%
  • In 2000, they were up 6.4%.
  • In 2001, they were down 5% and down another 9% in 2002, both of which still outperformed the major indices in tough market times.
  • And despite the bear market of 2000 to 2002, Dogs of the Dow raced 29% higher in 2003.
  • By 2004, they ran up 4.4%, giving back 5% by 2005.
  • And by 2006, Dogs of the Dow ran up 30.3%.

Not too shabby given tough economic times, wouldn’t you say?

Again, ignore the January Effect. And instead, invest in the Resolution theory and the Dogs of the Dow, which we’ll reveal in the New Year.

Stay tuned for more.

Good Investing,

Ian L. Cooper