3 Reasons Why Dividend ETFs Have Been Losing Momentum

Includes: DTN, DVY, FVD, PEY, PFF, SDY
by: Gary Gordon

Head-strong Republicans demand permanent extension of the Bush-era tax cuts. Lame-duck Democrats look to stick it to the “wealthy.” All the while, the political game of chicken keeps the American people… as well as significant portions of its financial markets… in a continuous state of high anxiety.

What should one do about dividend-paying stocks today if capital gains go up to 20% on 1/1/2011? What might wealthier individuals do in 2010 to minimize the impact of higher tax brackets next year? How would an exodus by the wealthier folk who hold the majority of stock shares affect the markets at large?

It feels a lot like a Hollywood script. Picture the campiness of the 80’s classic “War Games,” mix in the vengeance of the 90’s film “Patriot Games,” and you’ve got yourself a screenplay with the title, “Tax Games.” Unfortunately, the current tax policy posturing is very real.

With the Dow, S&P 500, and Nasdaq all within spitting distance of new 52-week highs, you may not have noticed the impact on dividend stocks. Nevertheless, it’s there alright. What’s more, tax uncertainty is only one reason for the shaky standing of Dividend ETFs.

2-Day December Rally Less Impressive For Dividend ETFs
Approx % 12/1-12/2
Wisdom Tree Dividend Top 100 (NYSEARCA:DTN) 2.7%
First Trust Value Line Dividend (NYSEARCA:FVD) 2.6%
iShares DJ Select Dividend (NYSEARCA:DVY) 2.6%
PowerShares High Yield Dividend Achievers (NASDAQ:PEY) 1.5%
SPDR S&P 500 Trust (NYSEARCA:SPY) 3.5%
Dow Industrials Diamond (NYSEARCA:DIA) 3.3%

1. Tax Policy. While there’s a high degree of probability that Bush-era tax cuts will be extended for everyone, there’s uncertainty about the duration of an extension (e.g., 1 year, 2 years, 3 years, etc.) as well as the timing of the “deal.” I believe it’ll get done prior to year-end, but some folks believe the lame-duck December Congress will balk at new legislation. It’s certainly possible that a retroactive bill would be introduced in January, hampering decision-making here in December.

2. Narrowing Yield Spreads. High-yield bonds, preferred stock, MLPs, convertible bonds and dividend stocks have tended to move with the general “risk-on, risk-off” trade. If stocks were heading higher, you’d see moderate capital appreciation in these vehicles, and when stocks headed lower, you would see moderate depreciation. With the 10-year yield catapulting from 2.4% to 3.0% in a month’s time, however, the spread between Yield-Oriented ETFs like iShares Preferred (NYSEARCA:PFF) or SPDR Dividend (SDY) and Intermediate Bond ETFs have narrowed. Consequently, investors recalibrate the risk associated with higher-yielding assets.

3. Large Company, Small Company. With the exception of most real estate data, the U.S. economy has shown definitive signs of improvement. It follows that investors are choosing small and mid-sized company ETFs that hold corporations which primarily serve the American public. Most small- and mid-sized ETFs have already hit fresh 52-week highs. Meanwhile, large corporations derive a huge chunk of revenue and profits from overseas operations. At present, the weakening of the euro and the slow growth of the EU economic region act as tailwinds to Large-Cap ETFs. The overwhelming majority of Dividend ETFs focus on long-standing, “been-around-forever,” large corporations.

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.