Stock dividends are in jeopardy on multiple fronts. This is not good news for equity income investors or the US stock market overall. Four forces are converging on and against US dividends:
- Companies are cutting dividends or not raising them
- Tax trap in existing dividend tax rules
- Congress will legislate higher dividend taxes after 2008
- Possible legislative mandate for TARP participants to suspend dividends.
The delicate condition of investor psychology, the simple math of dividends as part of total return, and the comparative yield opportunities in developed foreign markets, suggest that declining dividends would depress US stock prices.
Simply put, US stock prices would decline.
Dividend oriented funds (DVY, VIG, SDY) would possibly suffer most. Foreign developed market dividend focused funds (IDV, DWM) would possibly be more attractive than US dividend funds, although they would suffer the same tax problems as US dividend funds.
Company Dividend Actions:
WSJ, Oct 21:
The prospects for dividends remains extremely cautious,” added Mr. Silverblatt [senior index analyst at S&P], specifically highlighting financials. Nonetheless, he noted more than half of all dividend-paying S&P 500 members expected to boost outlays in 2009. Among them won’t be General Electric Co., which recently announced plans to not hike its dividend in 2009 for the first time in 33 years.
CNN, Oct 27:
… the recent surge in dividend cuts could accelerate as more companies run into financial trouble. S&P on Oct. 21 reduced its estimate for the collective annual dividends paid this year by S&P 500 companies by 80 cents per share from $28.85 to $28.05.
S&P also expects total dividends paid by S&P 500 companies for the fourth quarter will drop 10 percent, to around $60 billion from $67 billion in the fourth quarter of 2007, the biggest year-to-year decline since 1958. Some fear more companies will feel free to cut dividends now that a trend has set in.
Wall Street Journal, Oct 29:
More real-estate investment trusts are expected to sacrifice their dividends as broader market turmoil drains their liquidity and hinders debt refinancing.
LaSalle Hotel Properties said last week that it cut its annual dividend by 51% to provide $100 million in liquidity over the next 26 months. The hotel REIT, whose shares have fallen more than 70% so far this year, is considered to be in the vanguard.
… Rich Moore, an analyst at RBC Capital Markets, said REITs aren’t being rewarded for their rich dividends amid dramatic stock-market declines. “I think you are going to see more [dividend cuts] because they can take the money and pay off debt,” he said.
Current Dividend Tax Trap:
Market Watch, Oct 21:
If a dividend-paying company fails to make a profit this year amid the financial turmoil, and consequently doesn’t pay federal income taxes, dividends that investors take as cash could be taxed at a 35 percent rate rather than the typical 15 percent for so-called qualified dividend income, Silverblatt [senior S&P index analyst] said.
New Dividend Tax Rates:
If Obama wins, which seems probable, and if the Congress becomes controlled by Democrats, which seems possible to probable, the favorable tax treatment of both dividends and capital gains will be reduced. Some talk is of reclassifying dividends as ordinary income, and ordinary income tax rates will rise too.
That would be bad for stock prices, and worse for equity income stocks and their investors in particular.
Possible Congressional Mandate to Suspend Dividends:
There are trial balloons going up in Washington about a possible ban on financial companies from paying dividends if they receive government aid under TARP.
The financial sector accounts for about 15% of the S&P 500 market cap, and generates high yields compared to the other sectors. If major banks stopped paying dividends, the yield on the S&P 500 would decline significantly more than it would otherwise. That would probably have strong negative impact on stock prices.
Washington Post, Oct 30:
“The whole purpose of the program is to increase lending and inject capital into Main Street. If the money is used for dividends, it defeats the purpose of the program,” said Sen. Charles E. Schumer (D-N.Y.), who has called for the government to require a suspension of dividend payments.
Bloomberg, Oct 31:
House Financial Services Committee Chairman Barney Frank said banks using cash from the $700 billion U.S. rescue plan for bonuses, acquisitions and other purposes unrelated to lending are in “violation” of the law.
“I am deeply disappointed that a number of financial institutions are distorting the legislation,” Frank, a Massachusetts Democrat, said in a statement today. “Any use of these funds for any purpose other than lending — for bonuses, for severance pay, for dividends, for acquisitions of other institutions, etc. — is a violation of the terms of the act.”
Senators Dodd and Sanders intend to take steps to limit uses of bailout money for bonuses and to extend government powers to reclaim money without the need for bankruptcy, if the money is not used as intended. They are only talking about executive compensation for the moment, but if the “no-dividends” idea is blended in, the outcome will not be good for US stocks.
Bloomberg, Oct 31:
"When you invite the government into your living room, which is what you’re doing with the TARP program, I can’t guarantee you they’re going to be a good guest in your house,” said Gerard Comizio, senior partner at Paul, Hastings, Janofsky & Walker LLP and former deputy counsel at the Office of Thrift Supervision. “This program is basically a work in progress."