How much of the recent sell off is driven by the fear of a new tax regime in the US?  Ordinary income, Long-term capital gains and Dividend tax rates are all set to rise significantly unless Congress acts before the end of the year.  Spending cuts to the Department of Defense with diminished sales to its suppliers, and regulatory pressures on the energy industry have also pressured the equity market.   These concerns, as well as the election and the standoff over the Fiscal Cliff, have been the catalysts of a 5 plus % sell off in the S&P 500 since the election. 

Dividends have been a big reason to own equities, with the yield on the S&P 500 much higher than the U.S. 10 year Treasury.  The possible jump in rates could be dramatic -- from 15% to ordinary income tax rate levels, coupled with close to a 4% rise for Obama Care.  This means that, for tax payers making $250,000 or more, Dividends would be taxed at close to 40% at the Federal level. 

Many sectors have felt direct pressure since the election, including Energy and Defense.  Looking at their respective ETFs (XLE & XAR), they have underperformed.  The XLE and XAR are down 5.64% and 6.00% respectively.  Higher tax rates have dominated much of the coverage of the Fiscal Cliff and dividends are in the cross hairs of those looking to raise revenues.  High dividend payers are not the domain of any one sector and owning a portfolio of high paying dividend stocks should provide some sector diversification.  However, since most Mutual Funds’ tax years have concluded already it appears that individual investors and Hedge Funds are selling dividend stocks ahead of a possible rise in tax rates. 

Since the close on Election Day, 11/06/12, until the close on 11/15/12 the S&P 500 is down 5.09% on a total return basis.  We compared this to the total returns of the 50 stocks from the S&P 500 with the highest dividend yields for last 12 months as seen in the table below.  This group was down an average of 5.75% over the same time period, a 0.66% underperformance.  Yet when looking at the top 10 dividend yield stocks over that time frame, the performance was even worse with a negative 7.30% average return.  Therefore, owning an equal weighting of the top 10 Dividend yield stocks since the election was expensive, costing investors over 7% in absolute terms, a 2.21% underperformance compared to the S&P500.  When looking at the top 50 estimated dividend yielding stocks, as calculated by Bloomberg, the performance story is almost identical with an average return of -5.78% and a top 10 average return of  -6.91%.  Obviously, there is a great deal of pressure on stocks that return capital to shareholders in the form of dividends.    

As the market continues to sell off, these are names to keep an eye on.  The performance of high dividend paying stocks can be expected to remain volatile for the near future, both to the upside and downside.  The selling may continue to feed on itself, but if a deal on dividend tax rates can be reached these names may at least revert to the mean and outperform the broad market.

When JP Morgan was asked what the stock market will do his response was, “It will fluctuate.”  That is sage advice for today’s market and having a strategy to deal with those fluctuations has a place in every investor’s portfolio. 

(c) Carne Capital

www.carnecapital.com

             
 

Remember, if you have a question or comment, send it to .

Contact Us | Privacy Policy