How the 'fiscal cliff' will impact your dividend paying stocks
As the end of the year nears, investors remain jittery over the “fiscal cliff.” This is the $607 billion expiration of a combination of tax cuts and the beginning of a large amount of automatic spending cuts that is set to occur on January 1 unless Congress and the White House reach an agreement. Many analysts point to nervousness over the fiscal cliff as the reason why the stock market dropped last week by the most in one week since June. The taxes that would most directly affect investors are the potential increases on taxes for dividends and capital gains – capital gains would revert back to 20 percent for long term gains and dividends would return to being taxed at a taxpayer’s marginal income tax rate.
- Over the past month investors have sold high dividend paying sectors. Telecom’s forward Price-to-Earnings ratio has declined from 17.5 to 16.6. Utility stocks have decreased 6.4 percent over the past month. Consumer staples’ forward P/E has fallen to 13.*
- Selling investment winners or losers for tax reasons is a logical action by investors, but collectively this selling can cause certain stocks to deviate from their fundamental value. When purchasing stocks that I feel are undervalued, I first ask myself why they are trading in that manner. Many times the answer is that the stock is not actually cheap, and the market is discounting the stock because of a future earnings/sales/debt/dividend problem. Yet, on other occasions the stock is trading cheaply because investors are acting irrationally toward the stock over the short term. This irrationality can be caused by something as rational as selling stocks for tax reasons. This has led to a historical phenomenon: the January effect. The January effect is that institutions and traders sell off stocks for tax reasons and portfolio dressing. Then they start buying again in January. Since 1991, the average January return on the S&P 500 Index has been over 7 percent.*** What is the conclusion? Don’t panic, and if some stocks start to look attractive, consider making a purchase.
**Performance 2012. 13 Nov. 2012. Yardeni Research, Inc. 14 Nov. 2012. <http://www.yardeni.com/pub/PEACOCKPERF.pdf.>
***Wasik, John F. Playing the “January effect.” 9 Jan 2012. Reuters. 14 Nov. 2012. <http://www.reuters.com/article/2012/01/09/us-investing-januaryeffect-idUSTRE8081XI20120109.>
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