The fiscal cliff might not be a steep drop for stocks
The fiscal cliff might not be a disaster for dividend stock investors after all, suggests James Morrow, portfolio manager at Fidelity, in a new Fidelity Viewpoints editorial.
One of the scariest fiscal cliff realities is the scheduled end of long-term capital gains treatment for dividends at the end of 2012. Instead of being taxed at 15%, the top tax bracket could end up paying 43.4% starting next year.
Yet Morrow suggests that the tax increase could be a non-event in the markets for three reasons:
1. Top dividend-paying stocks did not outperform after the dividend tax cut was enacted in 2003. To the contrary, the top 20% of S&P stocks ranked by dividend yield performed worse 12 months after the dividend tax cut than they did prior to it. Reverse the polarity, and those stocks might not underperform if dividend taxes are now raised.
2. The market should anticipate a dividend tax increase to some degree, the way it does with most any scheduled event. If so, you would expect investors to already be moving out of income-oriented stock funds in favor of other stock investments prior to taxes going up. That has not happened. To the contrary, investors are favoring equity income funds. They have risen more than 20% in the past 12 months; all domestic funds together have shown virtually no growth over that same timeframe.
3. Bond yields remain historically low. A 10-year Treasury is now yielding less than 1.8%. The long-term average yield going back to 1962 is 6.7%, according to Yahoo Finance data. It’s not enough for many retirees. Financial planners often plan on having retirees withdraw about 4% a year from their investments to cover living expenses. That may boost retirees’ demand for other forms of investment income, including dividend-paying stocks.
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