Although the S&P 500 Index finished 2011 at break-even in terms of simple price appreciation, it was anything but an uneventful year. Fundamentals did not seem to matter anymore as the markets became news-driven, ebbing and flowing with every major update and speculation from Europe and the U.S. debt ceiling fiasco. The volatility has continued into 2012. An unusually warm winter inflated economic readings and drove U.S. stocks to the best first quarter in more than a decade. But as reality set in for the U.S., China’s growth slowed, and Europe’s crisis escalated, most of the early gains have been wiped out.
In a recent Leeb’s Market Forecast, we charted how defensive stocks outperformed when market anxiety is high. In fact, the same logic extends to funds too. This month, we take a look at how some funds tracking generous dividend paying stocks performed vis-à-vis SPDR S&P 500 (SPY), an ETF tracking the S&P 500, a good proxy for the broader market.
The graphs below compares SPY’s total return performance against SPDR S&P Dividend ETF (SDY), iShares Dow Jones Select Dividend Index ETF (DVY), and ELEMENTS Dow Jones High Yield Select 10 Total Return Index ETN (DOD) from 2010 through 2011. All three convincingly outperformed in 2011, evidence of the increased popularity of dividend payers last year. And as the graph below illustrates, even when the general market was strong in 2010, they still all beat SPY, albeit by smaller margins than in 2011.
SDY seeks to replicate the returns of an index of the 60 highest-yielding stocks from the S&P Composite 1500 Index, which covers approximately 90 percent of total U.S. market capitalization. Members of the index have increased dividends every year for at least 25 consecutive years and are subject to minimum market cap and trading volume requirements. Current yield: 3.1 percent.
DVY is linked to a Dow Jones index of 100 of the highest-yield U.S. stocks selected from the Dow Jones U.S. Total Stock Market Index, which covers nearly the entire U.S. stock market capitalization. Besides requiring attractive yields, the index screens stocks by other metrics like dividend growth rate and payout ratio. Current yield: 3.4 percent.
DOD is an exchange-traded note, or ETN, debt instruments whose returns are predicated on the performance of a particular index. In DOD’s case, it tracks the eponymous index, comprised of the top ten yielding companies in the blue chip Dow Jones Industrial Average.
Blue chip stocks, deemed to be safer than most, offer an extra layer of protection when market risk is high. Plus, risk is mitigated through sector diversification, not to mention the Dow's periodic rebalancing, which forces out underperforming companies and replaces them with faster-growing, more stable blue chips. Therefore, it’s not surprising that in the post-financial crisis era, this ETN was the top performer in our exercise. Note that DOD itself does not pay a dividend but its return reflects the gains in the stocks tracked.
As stocks got off to a very strong start this year and risk appetite ran high, SPY built an early lead, but over the last three months the dividend funds have once again proved their mettle, outperforming SPY. Over the upcoming months, if policymakers around the world unleash new rounds of stimulus, the dividend funds may underperform somewhat on the upside, but the underlying global risks make them prudent holdings to have for protection on the downside.