[PEN-L:33765] protection rents and "the greatest depression of all time"

["Ian Murray" <seamus2001@xxxxxxxxx>]

[ New York Times ]
January 12, 2003
Tax Plan Throws a Bone to the 'Dogs of the Dow'
By RICHARD TEITELBAUM


TAX-FREE stock dividends? Sure, Wall Street likes the idea, but the
prospect has one breed of stock pickers virtually yelping for joy.

That group, the followers of the "Dogs of the Dow" strategy, stands to
reap handsomely if the Bush administration's proposal to eliminate taxes
on most dividend income becomes law. That is because the strategy leads
investors to high-yielding stocks: payouts would be worth more if they
escaped the government's tithe, and the dividend-paying shares
themselves would likely receive a boost if investors flocked to them.

"We have here a possible change in taxes that will lead to a sea change
in investor thinking," said Francis D. Gannon, manager of the SunAmerica
Focused Dividend Strategy Portfolio, which uses the strategy to pick
about one-third of its holdings. "I think there's an enormous
opportunity."

Popularized by Michael B. O'Higgins in "Beating the Dow"
(HarperBusiness, 1991), the strategy in its classic form calls for
buying the 10 highest-yielding stocks in the Dow Jones industrial
average, called Dogs, because their prices tend to be beaten down. The
shares are bought in equal dollar amounts on Jan. 1 and held through
year-end. Then the process repeats, with the investor rebalancing the
portfolio among an updated roster of the 10 top-yielding Dow stocks. The
strategy was the rage for much of the 1990's, but fell out of favor in
the technology bubble as investors flocked to growth stocks that paid no
dividends, and has yet to regain its popularity.

Dogsofthedow.com, a Web site that tracks the strategy, identifies the
Dogs this year as Philip Morris, J. P. Morgan Chase, General Motors,
Eastman Kodak, SBC Communications, DuPont, Honeywell International,
General Electric, Caterpillar and AT&T. They were yielding an average of
4.20 percent on Dec. 31, versus 2.47 percent for the Dow industrials.
(There are different ways to calculate yield, so the roster may vary.)

Whatever the impact of rescinding the dividend tax on the overall
market, some portfolio managers say the move would prompt a
substantially bigger gain in the Dogs. Christopher N. Orndorff, a
managing principal at Payden & Rygel, a money management firm, estimated
that even a 50 percent reduction in the tax would send the Dogs up 10 to
15 percent in just a few months and 20 percent or more over 12 months.
"This thing has happened rather quickly," Mr. Orndorff said of the
proposed dividend tax elimination. "I don't think they have fully priced
it in yet."

Of course, he added, other factors could quickly reduce potential gains.
"If we have a fall-off in corporate earnings, the dividend tax cut won't
matter much at all," said Mr. Orndorff, who uses the Dogs strategy in
helping to manage the Payden Growth and Income fund.

Still, proponents contend that the Dog stocks are benefiting from a
variety of factors and are a good bet regardless of the final
disposition of the dividend tax. Given that 10-year Treasury notes yield
just 4 percent or so, investors have the luxury of earning bond market
yields on their stock holdings even without a tax advantage, said Neil
J. Hennessy, president of the Hennessy Funds, which runs two small
portfolios, Balanced and Total Return, that use the strategy. That kind
of yield parity, he said, does not occur often.

Mr. Hennessy said the Dogs could lead the market based on their own
merits. "Investor confidence is growing with these companies, since they
have the money to pay their dividends," he said. "They've taken their
write-offs, they've laid off people, they're lean now, and earnings are
going to surprise people over the next 12 to 18 months."

High-yielding stocks are likely to become more popular, he added, as
baby boomers enter retirement and begin searching for income-producing
investments.

The strategy generally outperforms down markets or those that tilt
toward value stocks, because it directs investors to some of the most
downtrodden stocks in the index. So Charles B. Carlson, chief executive
of Horizon Investment Services, a money management firm in Hammond,
Ind., said it would be unlikely to win in a rollicking growth market.

The Dogs have indeed been on a run, at least when compared with the
broader market. According to dogsofthedow.com, the Dogs beat the Dow
average in each of the last three years. In 2000, the Dogs returned 6.4
percent, versus a loss of 4.7 percent for the index. In 2001, the Dogs
lost 4.9 percent, still better than the 5.4 percent loss for the
benchmark. And last year, the Dogs were down 8.9 percent, versus a
decline of 15 percent for the index.

(For the 10-year period ended Dec. 31, the Dogs underperformed,
returning 12.8 percent, annualized, versus 13.3 percent for the broader
index.)

The Dogs of the Dow is not the only stock-picking strategy that could
benefit from the elimination of the dividend tax. Mr. Gannon said
investors could seek out companies that currently do not pay dividends
but may change their policies; such shifts would likely cause those
stocks to climb. Characteristics to look for are generous cash flows,
large amounts of cash on the balance sheet and low debt. Mr. Gannon
cites Microsoft (the only stock in the Dow industrials not to pay a
dividend), Cisco Systems and Dell Computer as three likely candidates.
Last year, Cisco shareholders rejected a proposal to institute a
dividend.

Playing the Dogs requires making some choices. Diversification
requirements prohibit mutual funds from investing more than 5 percent of
their total assets in a single stock, so funds that use the strategy
generally marry it to another investing discipline. Some unit investment
trusts - fixed, unmanaged pools of securities with a set life span - are
pure plays on the Dogs and are sold by many brokerage firms. Even with
loads and expenses, these can be cheaper for many investors than buying
individual stocks.

Mr. O'Higgins, meanwhile, who runs a money management firm in Miami
Beach, said he still believed the Dogs strategy would beat the Dow index
over the long term. But he has turned bearish with a vengeance, and his
firm now holds gold and Treasury securities and is short the Dow, the
Standard & Poor's 500-stock index and the Nasdaq 100.

Despite the bursting of the technology bubble and the subsequent bear
market, Mr. O'Higgins said he believed investors were still wildly
overoptimistic. "People haven't sold, mutual fund managers haven't
raised cash, and the brokerage firms haven't reduced their equity
allocations," he said. "It was the greatest mania of all time and will
be followed by the greatest depression of all time."