Stocks & Commodities V. 32:1 (36-38, 54): Outperform The Market With Sector ETFs by Todd and Steven Winkler

Outperform The Market With Sector ETFs by Todd and Steven Winkler

The Select Sector Strategy

Here’s a long-term strategy that is similar to the dogs of the Dow strategy, except that it uses Select Sector ETFs. Find out how this strategy can be used to outperform the S&P 500.

The dogs of the Dow is a well-known investment strategy that was originally introduced in 1991 by Michael B. O’Higgins and John Downes in their book Beating The Dow. The dogs of the Dow strategy involves the purchase of equal dollar amounts of the 10 Dow Jones Industrial Average (DJIA) stocks with the highest dividend yields and holding onto those companies for exactly one year. At the end of the year, the portfolio is adjusted as the cycle is repeated, the goal being to outperform the DJIA.

Whereas the dogs of the Dow strategy has proven itself to be viable and robust, we are proposing a similar yet alternative stock investment method, which we call the Select Sector strategy. It invests in market sector exchange traded funds (ETFs), as opposed to individual stocks, in an effort to outperform its broader stock market benchmark, the S&P 500 index. This strategy may appeal to investors who are more comfortable investing in market sectors as opposed to a relatively small number of individual company stocks as with the dogs strategy, or who think that the Select Sector strategy is simply superior. Our research indicates that the Select Sector strategy has indeed been able to convincingly outperform a proxy of its benchmark, the SPDR S&P 500 ETF (SPY), as well as the dogs strategy.

The strategy

Our portfolio of candidate ETFs is limited to the nine SPDR Select Sector ETFs underwritten by State Street Global Advisors. The complete list of these ETFs, along with their ticker symbols and accompanying percentage composition of the S&P 500 index, are given in Figure 1. The nine sectors are as follows: materials, energy, industrial, financial, technology, consumer staples, utilities, health care, and consumer discretionary.

Specifically, our Select Sector strategy involves the purchase of equal dollar amounts of the three worst-performing of these nine sectors in percentage terms from the prior year and holding them for one year. At the end of the year, the cycle is repeated with the portfolio adjusted accordingly. As with both this and the dogs strategy, the thought process is that there are repeating business cycles in which relatively weaker periods of stock performance are followed by relatively stronger periods.