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Dogs to Fall Short of Dow? ETFs in Focus

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The global stock market has been relatively choppy since the start of 2016 with a mountain of woes and increased volatility impeding investments. The never-ending fickleness in crude oil prices, global growth concerns and speculation over the Fed’s next move after the first rate hike in over six years last December weighed on investors’ sentiments, flaring up volatility to start the year.

Though markets came out of this slump soon, occasional hiccups derailed the market momentum especially with the Brexit decision in June end. As a result, dividend investing has been steady so far.

Along with several dividend-oriented investments, Dogs of the Dow – which represent the 10 highest yielding blue chip companies of the 30-stock Dow Jones Industrial Average (DJIA) and thus have higher dividend yields – had a stellar run in recent times. In 2015, the Dogs outperformed the Dow Jones Industrial Average benchmark by 100 bps (excluding dividend income).

The trend is similar this year as well with ELEMENTS Dogs of Dow DJ HY Select 10 TR ETN returning over 13% and SPDR Dow Jones Industrial Average ETF (DIA - Free Report) nudging up 4.2% (as of October 28, 2016) (read: Dogs Beating Dow in Wild Ride: 6 ETFs in Play).

Can Dogs of the Dow ETF Strategy Continue to Outperform?

The strength of the Dow Dogs started to weaken as the chances of a Fed rate hike in 2016 end increased. Apart from the Fed hike talks, slowly building inflationary pressures are leading to a gradual rise in Treasury bond yields.

The U.S. economy also picked up pace in Q3 having grown at 2.9% -- the highest growth in two years. This was a considerable improvement from the 1.4% record in Q2 and came in higher than economists’ expectation of 2.5%. This shows that the U.S. economy is steady enough to fan more Fed rate hikes in the coming days at regular intervals. As a result, dividend investing lost its usual flair.

In the last one month (as of October 28, 2016), DIA added about 0.1% while DOD was down about 1.1%. Apart from rising rate concerns, several factors should now be kept in mind to bet on dividend dogs. The attractive dividend yield does not necessarily suggest these companies’ financial strength.  They could be in the bottom of the business cycle. Also, the high yield can be the result of lower stock prices. An analyst also pointed out that the "Dogs of the Dow" strategy does not consider share buybacks, “which are functionally equivalent.”

If this was not enough, investors should note that dividend yields slipped in Q3 with large-caps at 2.12% (down from the 2.17% in Q2), mid-caps at 1.64 (1.68% in Q2) and small-caps at 1.31% (1.38% in Q2). Dividend ETFs are also guilty of overvaluation after a steep way-up in recent times (read: Is the Dividend ETF Bull Run Over?)

On the other hand, DIA displayed a better run lately. It has been noticed that Dow Jones shares a deep-seated relationship with oil price movement. In most cases, in a particular day of oil rout, the decline in Dow Jones is steeper than that of the S&P 500, or vice versa.

Investors should also note that United States Oil (USO - Free Report) added about 1.3% in the last one month (as of October 28, 2016) and might gain ahead if the OPEC manages to cut an output freeze deal in the November meeting. So, chances are there that if oil rallies, Dow may gain strength. But rising rate issues can drag down the Dogs going forward (read: How to Trade the Oil Rush with ETFs).

In the last ten days (as of October 28, 2016), DIA was up about 0.2% while DOD and ALPS Sector Dividend Dogs ETF (SDOG - Free Report) were off over 1.2% and 0.6%, respectively. Notably, SDOG yields about 3.37% annually. So, investors hungry for yields still may target such high-yielding options in quest for regular current income which can make up for capital losses (read: 6 ETF Areas to Watch as Fed Meeting Starts).

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