By
Russ
Koesterich
:
The election night parties were barely over last week before
investors started selling stocks. While renewed uncertainty over
Europe did not help, the source of the volatility was closer to
home: The fiscal cliff. Washington now has seven weeks to reach a
compromise - a failure to do so will mean the largest fiscal drag
in the post-World War II period and a possible recession.
Many investors are particularly worried that dividend stocks are
vulnerable given the potential for a near tripling of the tax on
dividends. As I've said in
previous blogs
, I believe volatility will remain elevated and stocks will stay
under pressure until the president and Congress produce a credible
road map to a compromise. That said, I don't believe dividend
stocks - with one exception - are any more vulnerable than the
broader market. Here's why:
- Many dividend stocks are held in non-taxable accounts.
Whether held by institutional investors or by individuals in
tax-deferred retirement accounts, a change in the dividend tax
rate will have no immediate impact on holders of these
securities.
- Historically, when dividend tax rates have risen, companies
have made investors whole on an after-tax basis by raising their
dividends to offset the higher tax rate. Given that U.S.
corporate balance sheets are generally very healthy with S&P
500 companies sitting on more than $2 trillion in cash, and
payout ratios are close to historic lows, companies appear to
have the wherewithal to increase dividends should taxes
rise.
- Many high dividend payers are concentrated in defensive
industries, like healthcare and consumer staples. These companies
tend to be less economically sensitive than other industries. As
a result, they typically outperform when the economy is under
threat because they're less vulnerable to a fall in earnings than
more cyclical companies.
While I'm comfortable with dividend paying stocks in general,
there is one major exception: U.S. utilities. Prior to the Bush tax
cuts in 2003, utility stocks typically traded at a significant
discount to other segments of the market. This made sense because
utilities are a slow-growing, regulated industry. However, since
the inception of the Bush tax cuts, the sector has been growing
progressively more expensive relative to other segments of the
market. Today, U.S. utility companies are trading at a slight
premium to the broader market. Should the preferential rate on
dividends expire, I believe the utility sector may be uniquely
vulnerable because it is likely to suffer significant
multiple compression
.
Over the next seven weeks, investors will need to spend a
disproportionate amount of time handicapping the odds of going over
the fiscal cliff. If the tax hikes and spending cuts hit, and they
are allowed to remain in place for any length of time, I believe
that the United States is vulnerable to another recession. Under
this scenario, stocks will come under significant pressure.
However, in the event of another recession, the tax rate on
dividends may be the least of an investor's worries. Dividend
stocks will be hit, but probably no worse than the rest of the
market. If anything, a defensive tilt - ex-utilities - is probably
a reasonable place to hide.
Source: Bloomberg
Original Post
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