Interesting Trends in Dividend Stocks, Munis 1 Week After Obama’s Win [CHART]

by Darwin on November 15, 2012

I haven’t done much with my portfolio over the past several months because I anticipated that regardless of who won the election, the fiscal cliff and its associated hikes in dividend tax rates would be resolved in short order and the market shouldn’t react too much one way or the other leading up to it.  Our Congress has been so adept at just kicking the can down the road and continuing to delay any hard decisions, that we’d probably see more of the same.  I figured markets would anticipate that and we wouldn’t see substantial market moves one way or the other due solely to the fiscal cliff issue.  I was wrong on that judging by market reaction since Obama won the election.  Markets have been down, but to be fair, I think the implosion in Europe has something to do with it as well.  Trying to keep up with which of Petraeus’s mistresses was involved in what has distracted news organizations from reporting real news, but in case you’ve missed it, the situation in Europe continues to worsen (anti-austerity protests rock Europe).

Regardless, since Obama’s election win, and rhetoric out of the Whitehouse, it looks as though they’re going for political gold.  There was much talk today about tax hikes on the wealthy, increases in “revenue” of more than double what was previously discussed ($1.6 Trillion over 10 years vs. $800 million) but no real discourse at all around reigning in entitlement spending.  So, stripping out politics and focusing solely on the tax issues for investors, that could potentially spell higher rates for dividend paying stocks.  A high net worth investor, if paying federal taxes on dividends at the 39.6% top bracket rate, could end up paying taxes of about 44% due to the added burden tied to Obamacare’s “fee” on investments for high net worth individuals as well.  So, dividend investors used to paying 15% now and that could triple.  It should come as no surprise then, if dividend stocks do sell off from high net worth individuals.  I’d like to think that there would be enough investors under the income cap that would see the value in dividend payers (or, people that are shielded from taxes in their Self-Directed IRA like me), but only time will tell.

At least in the near-term, there’s been an interesting divergence in dividend stocks versus muni bonds.  Taking two large and popular benchmark ETFs (SDY is the S&P Dividend Index and MUB is iShares S&P Muni Bond Fund) and comparing to the S&P 500 (SPY), you see the following:

(click to enlarge)

 

What we see is that the broader market SPY and dividend yielders SDY dropped substantially this past week over 2%, while MUB actually gained during the selloff.  This makes sense in that investors may be fearing higher taxes on dividends (and potentially capital gains as well), while municipal bonds and muni bond ETFs enjoy triple tax free status (check out this muni bond resource to get more ETFs and other high yielding instruments).  If massive amounts of capital were to flee equities and high yield and shift into munis, this trend would likely continue.  Does this mean muni bonds are the next hot bubble to jump into before it eventually peaks?  Possibly.

Should Routine Retail Investors Invest in Muni Bonds?

While the potential trend developing here may accelerate as we approach the fiscal cliff, I haven’t been an avid believer in munis myself because I have a relatively low tax rate.  If MUB is yielding ~3%, someone with that 44% tax rate on dividends may feel like they’re getting close to a 6% tax-equivalent yield.  But for me, where I would probably continue to be paying the same 15% dividend tax rate as a “Middle Income American”, it might only be a 3.5% tax-equivalent yield.  I’m almost inclined to wait it out and just buy more higher yielding instruments on the dip.  This could pay out any number of ways, but I haven’t been writing much on investing lately so thought I’d share some thoughts.

If looking for some really high yielding ETFs during such a buying opportunity, consider the following:

What Are Your Thoughts on Dividends, Munis and Taxes Going Into the Fiscal Cliff?

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