A Tale of Two Markets

Caterpillar Inc. signage is displayed on a monitor on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Friday, June 17, 2016. U.S. stocks retreated, resuming a drop that has sent them lower in six of the last seven days, amid selling in health-care and technology shares that have been the market's weakest all year. Photographer: Michael Nagle/Bloomberg

In a time of low economic growth and even lower interest rates, a year to date return at this time of year of 2.6% may seem fairly decent. This is the current return (Jan 1 to Nov 4 2016) of the Dow Jones Industrial Average (DJIA) index. The DJIA is one of the key indicators of the health of the U.S. stock market, and with all the uncertainty caused by the U.S. presidential election, a 2.6% return doesn’t seem all that bad. The DJIA is made up of 30 of the largest U.S. companies by market capitalization, and is one of the bellwethers for the health of the US stock markets.

But when one looks a little closer at the individual stock performance of the DJIA components, once sees a very interesting development. Of the 30 components of the DJIA, 12 have had negative results year-to-date. Many DJIA components have showed very poor returns since the beginning of the year, led by Nike which is down 20% on a price basis. (see Table 1).

picture-1At the same time, 18 DJIA components have had strong positive results year-to-date, with nine showing returns over 10%, led by Caterpillar at 20% (see Table 2). These stocks are responsible for the bulk of the index’s overall positive performance year-to-date.

picture-2This dichotomy among the DJIA components indicates that it isn’t just a simple strategy of picking the largest capitalization stocks and letting them run. Selecting the right large cap stocks is as important for a strong return as anything else. This is especially true when the general stock market index, like the DJIA, is in a modest positive move, as has been the case this year.

In this kind of market, it requires time and effort to increase one’s confidence level to pick the stocks with the highest probability of outperformance. As an example, take this year’s leaders, Caterpillar and Chevron. These stocks were under performers over the past 18 months, dropping by about 45% each to late in 2015. This year has been a big turnaround for both of them, even though oil prices and economic growth has remained poor. Also, if one thought that pharmaceuticals would be a good sector bet for 2016, two DJIA pharmaceutical components moved in opposite directions: Merck & Co. has had a strong run this year, while Pfizer has been disappointing.

Michael Zienchuk, MBA, CIM
Investment Advisor, Credential Securities Inc.
Manager, Wealth Strategies Group
Ukrainian Credit Union
416-763-5575 x204

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