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Boon for bruised stocks?

For Wall Street, the centerpiece of President Bush’s proposed economic stimulus plan is the elimination of the taxes individuals pay on stock dividends. But Wall Street strategists are divided over whether it will be enough to drag the the market out of the doldrums.
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For Wall Street, the centerpiece of President Bush’s proposed economic stimulus plan is the abolition of the taxes individuals pay on stock dividends. The dividend tax cut is designed to put more money into shareholders’ pockets and boost stock prices, but Wall Street strategists are divided over whether it will be enough to drag the market out of the doldrums.

The President's tax package includes spending and tax cut proposals totaling amounting to $674 billion, more than twice the amount under consideration just one week ago.

In addition to calling for the elimination of the tax on dividends — estimated to cost the U.S. Treasury $364 billion over 10 years — Bush proposed an immediate acceleration, retroactive to Jan. 1, of the tax rate cuts that had been scheduled to take effect in 2004 and 2006 and an extension of federal employment benefits.

The Bush Administration hopes the full elimination of dividend taxes for individuals will be a boon for browbeaten investors and the struggling stock market.

Tax law has discouraged companies from issuing dividends, as they are essentially taxed twice — once as company income and again when paid out to company shareholders. “Double taxation is bad for our economy and it’s wrong,” the President said in a speech before the Economic Club of Chicago in which he outlined his “growth and jobs” economic stimulus plan.

Economic climate sluggish
The current economic climate is still sluggish. Unemployment is creeping higher and there are signs that consumer confidence is waning. At the same time, business investment remains tepid at best and the potential for a war with Iraq is weighing on stock prices.

So with over half of the nation now invested in equities, whether directly or through pension funds, and stock prices down for a third-straight year, the thinking goes that if Congress agrees to eliminate dividend taxes it will boost demand for stocks, and by putting more funds in investors’ portfolios it will in turn shore up consumer confidence and prevent the current economic recovery from stalling.

“Any time you give investors the opportunity to keep more money in their pockets it’s a positive,” commented Peter Cardillo, chief strategist at Global Partners Securities. “I think this plan will really boost the stock market because it will encourage investors to invest in better-performing, dividend-paying stocks.”

The beneficial effects of the plan may already be playing out in the stock market. Stocks of companies that pay dividends to investors, including Dow component J.P. Morgan Chase, led a broad rally on Wall Street on Monday, as investors calculated that the President’s tax package would bolster the stock market.

The Standard & Poor’s 500-stock index, the broadest measure of the market’s health, climbed 2.3 percent Monday and posted an notable gain of 5.6 percent for the first three trading days of the year.

But even before news of the Bush tax proposal, investors were edging toward dividend-yielding stocks, looking for steady sources of income after an extended bear market and a series of corporate governance scandals.

Dividend-paying firms outperformed non-dividend paying firms by a wide margin in 2002. And in December the S&P 500 index fell 6 percent compared with a flat performance for the index’s largest dividend-paying stocks.

Looking ahead, A.C. Moore, investment strategist at Dunvegan Associates in Santa Barbara, Calif., doesn’t anticipate anything more than a subtle shift towards dividend-paying stocks on the part of professional money managers.

“There won’t necessarily be a change in investment strategy; investors won’t be going on a hunting spree for dividend-paying stocks, but we’ll be willing to pay a higher price for companies that offer a dividend,” Moore said.

Moore adds that companies now sitting on large cash reserves, including high-tech firms that have preferred to avoid paying dividends and have focused on expansion investments, may now face more pressure from stockholders to pay out dividends.

These companies include names like Internet networking giant Cisco Systems, with cash reserves totaling around $21 billion, and other cash-rich tech giants like Dell, Microsoft and Oracle. (MSNBC is a Microsoft-NBC joint venture.)

An executive from Oracle said Tuesday that the software maker would consider paying a dividend if taxes on them are repealed. Dell said a decision on the dividend issue would factor into its decision on how to invest the company’s available cash, while Microsoft, with about $40 billion on hand, said it has no immediate plans to pay a dividend.

Traditionally, companies in the energy, utilities and tobacco sectors have paid out the highest dividends.

Dividend payers to outperform
Kent Engelke, markets strategist at Anderson & Strudwick, is more bullish than most of his counterparts.

In the year ahead, stocks paying a dividend are likely to outperform non-dividend paying stocks, Engelke said, as investors look to invest in higher-yielding securities because of the tax break they would receive.

Engelke thinks the Bush tax proposal, if passed in its current form, would receive a warm reception on Wall Street, possibly lifting the Dow Jones industrial average to 10,500 and the Nasdaq Composite index above 2,000.

Indeed, Ed Hyman, chairman of investment firm ISI Group, said in a CNBC interview Tuesday that he thinks the economic stimulus package could add 8 percent to the value of the S&P 500 index in 2003.

However, the implementation of the current Bush tax proposal relies on the Administration’s successful prosecution of a conflict with Iraq, according to Engelke.

“Everyone loves a conquering hero,” Engelke said. “The President already has a very high approval rating, and so if he can effectively deal with Iraq I think his economic stimulus package will be passed quickly and in its present form.

“If we get bogged down in the conflict the president’s approval rating might be dented and it will be much harder to get the package passed,” Engelke added.

Others on Wall Street are skeptical that the Bush proposal on dividend taxes will give the stock market anything more that a transitory boost.

The critics argue that the potential impact of the tax cut is overstated, as the mostly wealthy beneficiaries of the tax cut have a low propensity to spend any extra income they receive from the government.

The tax proposal faces a tough fight in Congress, they add, and any impact from the plan is unlikely to be seen by investors until they file their 2003 tax returns in spring next year, by which time the economy may already be on the road to recovery.

“Everyone on Wall Street is expecting the dividend tax cut to be wildly stimulative to the stock market and the economy, but I think it will be mildly positive at best,” said Chip Hanlon, president of Unfunds, an investment consultancy.

“I think the proposition to do away with taxes on dividends will get knocked down in Congress,” said Hanlon.

“In the end, we’ll get watered-down measures that won’t really address our huge economic problems. They’ll be politically attractive, as they won’t lower taxes for the rich and they won’t really free up capital from the wealthy where it’s locked up.”