Why the Dow's Due for Big Gains

Investors follow the Dow Jones Industrial Average (INDEX: ^DJI) so closely because its components represent the cream of the crop of the U.S. stock market. With companies that span nearly every industry and that usually have a leadership role over their industry peers, the 30 stocks of the Dow are giants in the global economy.

But for years, U.S. large-cap stocks like the ones that make up the Dow have failed to deliver strong returns for investors. Will that underperformance continue, or is it time for the Dow and its large-cap brethren to shine?

The future of large-cap stocks
In this month's brand-new issue of the Rule Your Retirement newsletter, which is available this afternoon at 4 p.m. EDT, Motley Fool retirement expert and financial planner Robert Brokamp takes a close look at the way that large-cap stocks have performed compared to other asset classes over recent years. Examining data going back 40 years, Brokamp weighs the evidence to come up with his conclusion about whether large-cap stocks look like the best prospects out there for the rest of 2012 and beyond.

Robert's analysis starts with a look at five major asset classes: large-cap U.S. stocks, small-cap U.S. stocks, international stocks, commodities, and real estate investment trusts. Although these investments don't cover the entire universe of available assets, most notably leaving out bonds, they do represent a wide swath of the riskier assets that investors turn to for portfolio growth.

Robert first observes that these asset classes tend to take turns in providing the strongest returns. U.S. large caps, for instance, had a great decade during the 1990s, when a big bull market rewarded sizable companies even more than their smaller counterparts.

But during the so-called "lost decade" of the 2000s, U.S. large-cap stocks like the ones that make up the Dow gave investors the worst returns of the five groups, losing an average of 1% per year. By contrast, small-cap stocks posted a 6.3% average gain throughout the decade, while real estate investment trusts posted a better-than-10% average return. Even international stocks and commodities managed to provide investors with positive returns.

Has the tide turned?
In 2011, though, large caps finally found their moment in the sun. Small-cap U.S. stocks lost significant ground, while the slowdown in Asia and the mounting sovereign debt crisis in Europe pushed most international stocks down as well. Real estate investment trusts performed fairly well, but commodities had mixed performance, with plunging natural gas prices a particularly strong example of weakness in the sector.

As Robert points out, experts have differing opinions about whether the turnaround for large-cap stocks indicates a longer-term trend. On one hand, stocks look relatively cheap, and in an environment in which gains have been hard to come by, the solid, dependable dividends that large-cap stocks usually pay in abundance can mean the difference between overall gains and losses. Increasingly, investors have come to appreciate dividend stability, as recent highs for Dow component and dividend leader AT&T (NYS: T) can attest. In AT&T's case, its growth prospects have set it apart from smaller telecom companies Frontier Communications (NAS: FTR) and Alaska Communications (NAS: ALSK) , despite the fact that the roughly 8%-10% yields on those two smaller competitors dwarf the 5% payout of AT&T.

Moreover, in a defensive environment, it's easier to find large-cap stocks that will hold up better in down markets than small caps. For instance, McDonald's (NYS: MCD) has established economies of scale that some of its competitors lack, making it easier for the fast-food leader to counter challenges and plot a course through tough times to profit. The stock's performance during the bear-market year of 2008 shows a great example of McDonald's resilience, as investors enjoyed gains even as the market plummeted.

Yet some experts believe that other factors explain large-cap gains. Robert cites Jeremy Grantham, an investment strategist with a long track record of smart calls, who argues that ultra-low interest rates make the market appear cheaper than it is. When that artificial prop goes away, stocks could lose the support that has held them up since the financial crisis.

Get the whole scoop
Smart investors need to know how to position portfolios to handle any market environment. This month's Rule Your Retirement gives a lot more advice on how to play large caps, including specific investment recommendations, analysis, and commentary. Best of all, you can get free access to the entire new issue through a 30-day trial subscription, letting you discover all the information, tools, and other resources that the newsletter offers. So be sure to tune in this afternoon to join the thousands of subscribers who benefit from Rule Your Retirement's guidance every month.

After a decade of underperformance, the Dow and the broader large-cap stock sector generally are due for some strong returns. There's no guarantee that they'll come right away, but given enough time, you can count on large-caps to take their turn in the sun.

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At the time thisarticle was published Fool contributor Dan Caplinger doesn't own shares of the companies mentioned. You can follow him on Twitter @DanCaplinger. The Motley Fool owns shares of McDonald's. Motley Fool newsletter services have recommended buying shares of McDonald's. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool has a disclosure policy.

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