In spite of the many challenges facing the global economy, the stock market has rallied in the past several weeks. Recent action by the European Central Bank and the U.S. Federal Reserve has helped to boost the markets. However, this looks like it could be a sugar-induced high that might not last for long. Economic data has been trending lower in many parts of the world, plus, the United States is facing a fiscal cliff and the reality that taxes are likely to rise. The combination of higher taxes and government spending cuts are likely to put pressure on the U.S. economy in 2013. This is likely to weaken the economy in the coming quarters, and that might put selling pressure on stocks.
Furthermore, popular dividend stocks could be particularly at risk because a proposed tax hike on dividend income might make this investment class far less appealing to investors. A recent article on CNBC summarizes the potential risks for dividend stocks, especially since many now trade near 52-week highs:
"Goldman points out that the 15 percent tax rate set to expire at the end of this year could more than double for many investors if President Obama wins a second term and his tax proposals are enacted as a resolution to the so-called fiscal cliff."
It goes on to state: "Tax rates on dividends are never going to be better," said Steve Joyce, CEO of Choice, on its last earnings conference call. "I don't know how much worse they are going to get, but they are going to get worse."
Two of the most popular dividend stocks for many investors have been AT&T (NYSE:T) and Verizon (NYSE:VZ). Both of these stocks have been performing well and now trade near 52-week highs. However, the higher stock price has increased risks of a decline and pushed the yields lower. Some analysts and investors believe a bubble is building in dividend stocks. One analyst at Alliance Bernstein (NYSE:AB) thinks that valuations are stretched for stocks like Verizon, since it now trades for about 17 times earnings. AT&T has a similar valuation in terms of PE ratio.
Both stocks are looking extended when you consider the 200-day moving averages. For example, the 200-day moving average for AT&T is about $32.58 per share, and the stock currently trades for $38.08. That indicates the stock is around $6, or 20% above the 200-day average. If the stock were to drop back to where it has averaged for the last 200 days, investors could lose about 20%, which is about four years' worth of dividends. Verizon shares have a 200-day moving average of $40.73, and the stock now trades at $45.64, or about 15% above the average. In this case, if dividend stocks or the stock market in general sees a correction, it would be increasingly likely for Verizon to test the 200-day average, which could be a drop of nearly 15%. That is equivalent to about three years' worth of dividends.
Investors seem to be getting complacent, and that is another sign that valuations are perhaps nearing a top. Like just about anything, there is a limit to how high these stocks can go. With the shares near a 52-week high, and with a fiscal cliff looming, along with a potentially significant change in the tax rates for dividend income, this might be a great time to take some profits. Raising cash now and patiently waiting for a better buying opportunity could reward investors in the future.
Here are some key points for AT&T:
Current share price: $38.23
The 52 week range is $27.41 to $38.28
Earnings estimates for fiscal year 2012: $2.39 per share
Earnings estimates for fiscal year 2013: $2.57 per share
Annual dividend: $1.76 per share, which yields about 4.7%
Here are some key points for Verizon:
Current share price: $45.62
The 52 week range is $35.06 to $46.41
Earnings estimates for fiscal year 2013: $2.49 per share
Earnings estimates for fiscal year 2014: $2.83 per share
Annual dividend: $2.06 per share, which yields about 4.6%
Data is sourced from Yahoo Finance. No guarantees or representations are made. Hawkinvest is not a registered investment advisor and does not provide specific investment advice. The information is for
informational purposes only. You should always consult a financial advisor.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.