Professional investors on Wall Street have welcomed the $350 billion tax-cut package approved by Congress last week, saying that even though it falls short of President Bush’s original proposal, it bodes well for companies that pay a dividend and for technology issues, which should benefit from investment tax breaks.
Late Friday, the Senate narrowly passed a tax cut bill that the U.S. House of Representatives had approved just hours before. Among its measures was a child tax credit, bigger tax breaks for business investments, lower tax rates on personal income and a reduction of taxes on dividends and capital gains.
The new, ten-year $350 billion tax-cut package that President Bush is expected to sign into law later this week is only about half as large as the $726 billion “jobs and growth” plan Bush initially proposed.
The centerpiece of the original Bush tax plan, put forward in early January, was the permanent elimination of all taxation on income derived from dividends.
Bush had argued the double-taxation of dividends was unfair, as it essentially taxed investors’ income twice. Its elimination would spur more investment in stocks, especially dividend-paying stocks, the thinking went, pushing the markets up by as much as 10 percent and eventually promoting economic growth.
Dividend taxation reduced
The double-taxation of dividends hasn’t been abolished in the latest tax bill. Instead, the top tax rate on dividends and capital gains has been reduced to 15 percent through 2008. Capital gains on investments held for over a year were previously taxed at 20 percent; dividends were taxed by as much as 39 percent.
Still, stock market strategists say the investor-friendly measures, although not as effective as the original Bush tax-cut proposal, will likely still have a significant impact on the financial markets, especially if provisions such as those for dividends and capital gains are eventually made permanent.
“The whole $726 billion tax cut would have been wonderful, but this is still a pretty good thing and the bottom line is it’s going to help the stock market and the economy,” commented Peter Cardillo, chief strategist Global Partners Securities, adding that, in the short term he expects to see a short-term positive reaction from dividend-paying stocks, like utilities.
Chip Hanlon, chief domestic strategist at Euro Pacific Capital, agreed. “You only have to look at the way dividend-paying stocks have been bouncing over the last few days to see that investors are looking to benefit from this,” he said.
Companies that have traditionally paid dividends, such as utilities, rallied earlier this year as the dividend tax cut was first proposed and have moved up again in recent days as a tax plan has appeared more likely, Hanlon said.
Other sectors that Hanlon expects to benefit from increased investor interest include big-name, blue-chip dividend-paying stocks, like General Electric and Altria Group, formerly Philip Morris. Other dividend payers, like AT&T, auto makers Ford and General Motors and chemical firms like DuPont and Dow Chemical may also benefit, Hanlon added.
“A lot of old-time industrial companies have suddenly become more attractive because of their dividend,” Hanlon said, but cautioned against buying stocks simply because they offer a dividend, as it doesn’t necessarily make them good long-term investments.
“It depends on whether you think the economy will actually recover,” Hanlon said. “People are searching through dividend-paying stocks right now looking for companies with good valuations and that’s why the sector has improved in recent days.”
Another sector of interest is energy trusts, or companies that own the production rights of certain energy fields. These companies typically have dividends in the 20 percent range, Hanlon said, and are benefiting from rising commodity prices.
Nasdaq 100 stocks gain
Kent Engelke, markets strategist at Anderson & Strudwick, said he thinks the planned breaks for capital investments — coupled with the falling U.S. dollar, which makes U.S. exports more competitive — are a benefit for technology stocks, as companies spend more money to buy new computer equipment.
Also, some large-cap technology companies, such as Oracle and Cisco Systems, have indicated they might follow the lead of Microsoft and start paying out a dividend.
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Engelke points out that the Nasdaq 100 index, which tracks the largest technology stocks on the Nasdaq market like PC-making giant Dell Computer, is up about 15 percent since the beginning of the year, moving ahead of the Standard & Poor’s 500-stock index, a broad market measure, which is up some 6 percent.
“This is getting priced in to the technology sector,” said Engelke. “I don’t agree that technology stocks are becoming overvalued; we may see them pull back a bit, but I really think they have seen a bottom and you could see a gain of 20 percent within a year.”
Reuters contributed to this story.