<FOOLISH FOUR PORTFOLIO>
Shorting the Dow -- NOT!
and an interesting problem
by Ann Coleman (TMF [email protected])
Alexandria, VA (June 15, 1999) -- The idea of a mechanical strategy that can identify stocks to short, as we discussed yesterday in Shorting the Dow, seems to have gotten a lot of people excited. Don't hold your breath.
Yesterday, I took a look at the returns of the 5 lowest-yielding Dow stocks since 1961. Surprise, they've done rather well in recent years. In the discussion about their unexpectedly strong showing, I said, "However, a bit more investigation into this phenomenon might be justified!" I should have been more clear. The phenomenon that I want to investigate is the idea of buying the low-yield stocks, not shorting them.
While I am not opposed to the idea of using our database to possibly develop a shorting strategy, I very seriously doubt that the limited data we have available (dividend yield and price -- that's about it) would be sufficient.
Let's take a minute to review why we limit our Foolish Four selections to the Dow (or S&P 30) companies. These are very strong companies. While there are always exceptions, in many cases when a Dow stock drops against the market it is because of unexpected bad news or a temporary drop in earnings (i.e., an earnings "surprise").
By definition, these are not things that one can easily foresee. And, if you were to short them, you would find that these stocks have this bad habit of rebounding. (I am speaking very generally, here, of course.) The more I think about it, the more I'm convinced that the last place you want to look for shorts is a list of very successful companies that have the resources to rebound quickly from bad news.
It's not enough that a stock not do well, remember. It has to actually go down, and by quite a bit, to make shorting profitable.
Of course, with 20/20 hindsight, one can pick out a number of good shorts from Dow stocks over the years. But I don't see a pattern, or even a hint of where to look for a pattern, and we don't have the kind of data that one would probably need to look at in order to find a pattern, if it existed, anyway. Shorts are probably best found somewhere else.
The high returns from the Low Yield 5 stocks are what interest me, but this is a fairly recent phenomenon. Up until 1985, they didn't do badly enough to warrant shorting, but they certainly trailed the market big time. However, since 1985, they have done remarkably well -- especially in bad markets. This presents us with a nice dilemma. Is the recent performance real? And what changed in the late '80s?
While there are many possible answers to that question (the bull market for one, possible changes in the makeup of the Dow to include companies that are more growth-oriented for another), my initial reaction to a change like this is mistrust. It is possible to flip heads 10 times in a row. What is going on here? If we can figure that out, we might be able to discover a way to smooth out some rough spots and provide decent returns even when the market heads south. But it will take some figurin'.
So we have a pretty problem. My favorite kind.
Fool on and prosper!
Today's Stock Lists | 1999 Dow Returns
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| 1999 Dow Returns
06/15/99
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Stock Change Last
--------------------
CAT -1 1/2 58.44
JPM +1 7/16 128.00
MMM + 9/16 89.81
IP +1 7/16 55.88
Day Month Year History
FOOL-4 +0.32% 3.86% 26.11% 27.98%
DJIA +0.30% 0.33% 15.78% 15.32%
S&P 500 +0.55% -0.04% 6.18% 6.44%
NASDAQ +0.68% -2.26% 10.12% 11.63%
Rec'd # Security In At Now Change
12/24/98 24 Caterpillar 43.08 58.44 35.65%
12/24/98 22 Int'l Paper 43.55 55.88 28.30%
12/24/98 14 3M 73.57 89.81 22.08%
12/24/98 9 JP Morgan 105.51 128.00 21.32%
Rec'd # Security In At Value Change
12/24/98 24 Caterpillar 1034.00 1402.50 $368.50
12/24/98 22 Int'l Paper 958.12 1229.25 $271.13
12/24/98 14 3M 1030.00 1257.38 $227.38
12/24/98 9 JP Morgan 949.62 1152.00 $202.38
Dividends Received $49.99
Cash $28.26
TOTAL $5119.38