There’s a recent piece in US News suggesting that now is a good time to sell off your dividend paying stocks. The reasons are myriad platitudes we’ve all heard before, but here are the key drivers for the recommendation:
- There have been big drawdowns from non-dividend equities while money has poured into dividend paying stock funds.
- Traditionally strong dividend sectors like telecom, utilities and healthcare are beating the broader market return (S&P500) on the year.
- Low interest rates have pushed investors into yield-generating stocks
- During a downturn, dividends are one of the first things a company would cut (hypothetically)
- If the economy grows faster than expected, that could have the result of pushing dividend payers out of favor
- Expiring tax cuts could raise taxes on dividends next year
Personally, I think most of these reasons useless arguments, perhaps to generate some controversy, but they don’t pass the test of practical reality. We already know Treasuries are going to continue to yield next to nothing for years to come, which means virtually all fixed income, savings, money markets and CDs are going to pay negative real returns for years. When interest rates start to rise, that could be due to one of two things – either an improving economy, which should actually benefit dividend paying stocks in that they have more free cash flow to increase payouts further OR the day of reckoning has finally come to the creditworthiness of the US and the bond market is demanding a higher interest rate to fund our debt. Obviously, under that scenario, dividend payers would fare better than cyclicals and growth stocks as well, as the economy sputters from the burden of higher interest rates and lower consumer spending.
As far as tax policy, making trades based on what Washington may or may not do is a losing proposition. We all know politicians don’t use logic or reason in their decisions and generally, in order to curry favor with the most voters, they take the path of least resistance (meaning the least cost to taxpayers, even at the expense of more debt). Therefore, I would anticipate that dividend tax rates do not increase, especially for the vast majority of Americans. In the even the tax rate did increase marginally, it probably wouldn’t impact valuations appreciably, as there would be no alternative income asset that affluent investors would flock to in its place, lest they see an increase in returns on those assets as well.
As readers of High Yield Edge are aware, over decades long periods of time, dividends have provided almost half the total return of equities over the years and there’s no reason to believe dividends won’t continue to account for substantive total returns into the foreseeable future.