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Obama’s Dividend Tax: More Fuel for Cyclical Stocks?

Any such move would likely make dividend stocks less attractive


“Certainty? In this world nothing is certain but death and taxes.” – Benjamin Franklin

With news of a potential dividend tax increase coming, thanks to the Obama administration’s desire to increase government revenue, it’s worth considering what the longer-term impact of the proposal could be on dividend-paying stocks. The president’s 2013 budget proposal includes a provision to raise the dividend tax rate on high-income earners.

“The budget plan would raise $206.4 billion over 10 years by treating dividends as ordinary income for married couples making more than $250,000 a year and individuals making more than $200,000,” according to Bloomberg. But the move may also have unintended effects on how investors put money to work.

Take a look at the chart showing the price ratio of the iShares Dow Jones Select Dividend Index ETF (NYSE:DVY) relative to the SPDR DJ Industrial Average ETF (NYSE:DIA). As a reminder, a rising price ratio means the numerator/DVY is outperforming (up more/down less) the denominator/DIA.

Click to Enlarge
I have annotated the chart to show that the peak in outperformance of dividend-oriented stocks seems to have been hit in late September, right before the “fall melt-up” I’ve written about before the October lows took place.

The ratio since late December has fallen off substantially as dividend stocks underperformed in this recent period that stocks went back up. The primary reason for this is the reflation theme  I keep stressing. Edward Dempsey, chief investment officer of Pension Partners, addressed this idea at length in a recent video market update.

Although the dividend tax rate proposal may not have a good shot of passing during this election year, even the outside possibility of higher taxes on dividends may be just another reason for dividend stocks to weaken: Money would avoid stocks that pay out capital in favor of those that offer capital appreciation and growth. In practice, this means cyclical sectors will likely continue to perform well as investors reallocate to areas that could provide better after-tax performance.

That trend, already in place, looks likely to continue for new reasons.

The author, Pension Partners, LLC, and/or its clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized advice. The opinions herein are not personalized recommendations to buy, sell or hold securities.

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