AP Photo/Matt RourkePresident Obama wants to reduce the deficit by raising taxes for the wealthy on capital gains and dividends
While the share of personal income coming from interest income has fallen to a generational low of about 9% in the United States, the portion coming from dividends has surged to a near-record of roughly 7%.
This is the smallest gap in history, according to Stéfane Marion, chief economist and strategist at National Bank Financial.
So with the Obama administration aiming to raise taxes on both capital gains and dividends, there is a risk that investors sell ahead of the changes.
While the maximum capital gains tax could rise from 15% to 20%, dividend taxes for the wealthy may rise from 15% to the rate of ordinary income at 39.6%.
With the S&P 500 up about 11% so far in 2012, Mr. Marion suggested investors may kick off a wave of “tax-hike” selling given the uncertainty about profit growth and tax increases.
“Having said this, politicians will need to tread carefully on the issue of dividends, which have become a key source of income for large segments of the population, retirees in particular,” the strategist said.
Barry Knapp, head of U.S. equity strategy at Barclays, believes the equity market will offer investors nowhere to hide in the near term.
“Stocks with high dividend yields – a key component to our theme of ‘stocks with bond-like characteristics’ – are likely to come under pressure as President Obama and Harry Reid renew their push to raise taxes on upper income filers,” Mr. Knapp told clients.
He doesn’t think the market is discounting the threat of a tax hike and recommends investors generally reduce risk.
“If stocks with bond-like characteristics get hit if it becomes apparent that dividend rates are likely to increase, we would add to positions in anticipation of a Fed monetary policy response,” the strategist said.
Deutsche Bank’s chief U.S. equity strategist, David Bianco, cut his year-end target for the S&P 500 to 1,450 from 1,475 on Thursday. He explained that President Obama’s re-election and Democrats retaining control of the Senate in anticipation of greater uncertainty on the dividend tax rate outlook.
“If the dividend tax rate increases to the marginal income tax rate we think it will weigh most on stocks that already have high dividend payout ratios – Utilities, Telecom, Tobacco, parts of Staples and Healthcare,” Mr. Bianco told clients.
“We do not expect a correction in these stocks, but find their PE premium to the market stretched given their high payout ratio and generally lesser growth.”