Risk/Reward Vol 27

F

THIS IS NOT INVESTMENT ADVICE.  IT IS A PERSONAL REFLECTION ON INVESTING.  RELY ON NOTHING STATED HEREIN

 

Yesterday, I discussed with a subscriber the impact of Congressional inaction on the dividend tax rate.  As it now stands, qualified dividends are taxed at a maximum of 15%.  Absent Congressional action, the tax rate on dividends will increase to one's marginal tax rate on January 1, 2011 which will be as high at 39.6% unless the Bush rates are renewed.  Republicans want to retain the 15%, and the White House has hinted it wants dividends taxed at 20% but has taken no definitive stance (SHOCKING).  The subscriber is concerned that dividend paying stocks will fall like a rock if rates go as high as 39.6%.  I am not so convinced for the following reasons.

 

First, according to the Conference Board, over 70% of the common stock of the 1000 largest U.S. corporations are owned by institutional investors.  Institutional investors (e.g. pension funds, mutual funds, etc.) are less tax rate sensitive than individuals because so many invest on behalf of tax deferred accounts (e.g. 401k's)

 

Second, of the remaining 30%, much is held by insiders who likely will not sell.

 

Third, there simply are no good alternatives.  The bonds of these same companies, interest from which will likewise be taxed at 39.6% , currently return less than dividends.  CD's and Treasuries pay even less.

 

Fourth, inertia.  Most people spend less time on investments than brushing their teeth.  Buy and sell is not dead.

 

Accordingly, for now at least, I am staying put and adding dividend payers where opportunity presents.

 

Speaking of the impact of increased tax rates, I think I will buy municipal bond CEF's more aggressively.  If they have a tax equivalent return of 9% at 35% marginal rates, they will return the equivalent of 10.3% if taxes rise to 39.6%.  I smell a buying opportunity.

 

I added to several positions in advance of Friday's rise.  I am going back into BP having bailed from a long time position in response to the spill.  I feel a big pop coming and am debating whether to go straight in or to buy options.  I see a real possibility of the current $38 hitting $55-60 once the dividend is reinstated.  What better way to introduce BP's new chairman, Bob Dudley, on October 1 than with such an announcement?  I am also looking at BP Prudhoe Bay Royalty Trust which has a 8+% return now, and .should increase in value once BP sells it.   The BP tarnish will be left behind.