Friday, July 22, 2011, Thomas Lee, an equity strategist with JPMorgan, published a note titled “Corporates are the New Sovereigns: 22 Stocks to Own Around Sovereign Default.” The Barron's article covering Lee's announcement defined a Sovereign as an entity which can print money or tax at will. Lee's report listed 22 corporate stocks that show less risk of default than the sovereign U.S. government based on five-year credit spreads, free cash flow yields exceeding bond yields, ratings of overweight by JPMorgan, and showing upside to their target prices.
The simple Dogs of the Index trading strategy described in previous articles will be used to document the net gains of the top fifteen JPMorgan New Sovereign stocks selected from the 22 listed in Lee's note.
The "Dogs of the Index" Strategy
An investing strategy that consists of buying the 10 dogs of the dow [Dogs of the Index] stocks with the highest dividend yield at the beginning of the year. The portfolio should be adjusted at the beginning of each year to include the 10 highest yielding stocks.
The investor focuses on just two key metrics that determine yields to rank the index dog stocks: (1) Stock Price; (2) Annual Dividend. Dividing the annual dividend by the price of the stock reveals the percentage yield by which each stock is ranked. After selecting top yielders from the JPMorgan list of 22 Sovereigns, the investor is able to follow, trade, and await the results from an investment in the lowest priced, highest yielding portion of the pool. A third variable of broker commission of $10 per trade will be deducted from every transaction to reveal net income. All the trades take place once a year.
Using data from Yahoo Finance, the following chart shows initial share amounts based on closing prices Friday 7/22/11 for the portfolio of fifteen JPMorgan New Sovereign Stocks selected to track now and for the next 11 months. Monthly result reports will be based on closing prices as of the Friday closest to the 22nd of each month: 7/22/11; 8/19/11; 9/23/11; 10/21/11; 11/25/11; 12/23/11; 1/20/12; 2/24/12; 3/23/12; 4/20/12; 5/18/12; 6/22/12; 7/20/12.
Color tints show the three tiers of the top 15: yellow for the top; cyan blue for the middle; magenta for the lowest. These colors work to highlight the repositioning of stocks between the three tiers based on dividend yields and price gains or (losses).
15 JPMorgan Sovereigns Ranked by Yield, July 2011
August Results by Yield
The yellow top tier of five JPMorgan Sovereigns held position based on yield. One equity from the magenta lower tier of five stocks, however, managed to move up into the cyan blue middle group. United Technologies (UTX) jumped up from position 11 to 9 while Norfolk Southern (NSC) moved from 12 to 11. Conversely Honeywell (HON) moved up from 9 to 8 while Coca Cola (KO) moved down from 8 to 10 and Hershey (HSY) sank from 10 to 12. Outside of those five moves among the middle and lower tiers little repositioning by yield happened in August.
15 JPMorgan Sovereigns Ranked by Yield, August 2011
click to enlarge
August Results by Stock Price Gain (Loss)
None of the fifteen JPMorgan sovereigns looked regal in August. Each stock showed a loss. Equities from the cyan blue middle tier spread out to take both top and bottom positions. Coca Cola (KO) moved from 8 to the 1 position because it lost the least money since July. Other consumer sector stalwarts from the middle followed KO. Pepsico (PEP) went from slot 6 to 2 and Hershey rose from 10 to 3. Honeywell (HON) lost the most and dropped to from 9 to15 while United Parcel Service (UPS) held the middle in the 9 slot. Interestingly, the Yellow Top Tier stayed together as a group near the middle while the magenta tier but for Honeywell stayed in the lower sector.
15 JPMorgan Sovereigns Ranked by Stock Price Gain (Loss), August 2011
click to enlarge
One month into this Dogs of the Index forward test, the stocks remain in nearly the same order by yield but diverge more markedly by price gain (loss) with all fifteen losing value since July. Note how the stocks with the better prices moved down the scale in yield and those with higher yields had greater price losses. These price to yield relationships create the Dogs of the Index strategy signals.
Comparing the drop in value of the fifteen JPMorgan Sovereigns to other indexes between July 22 and August 19, the Sovereigns dropped 14.9% while the Dow dropped 11.1%, the S&P dropped 16.8%, and the NASDAQ was down 18.0%. Fortunately the market is now in its summer doldrums and this forward test has eleven months to find some semblance of a bull market.Disclosure: I am long MRK.