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by TheMoosra at 8:43 pm on Tuesday 2nd March

Apologies for the extended absence from my post as political/financial contributor to HD. Now for the business end of things:

Growth stocks have outpaced income stocks in general over the last bull run 2001-2007. Cheap liquidity sloshed into growth stocks in the form of leveraged positions, and resulted in... well, growth. Income stocks were relegated to lower positions, as investors sought aggressive, active, alpha-origin returns rather than the more passive income from dividend yielding stocks. Those few which managed to be both, ie financial institutions, crashed horrifically over the GFC period (Great Financial Crisis, as it is now being called).

Some investment managers are suggesting a shift in fundamental risk appetite towards income stocks, as investors look for a smaller yet more reliable source of capital growth. In theory this would be a good portfolio management move, and is a play that comes right out of the textbook. A stock with a yield of 6%, say Vodafone, could shift over +-20% per annum yet still pay out 6% year on year. For a longer term investor, long-dedicated fund manager, pension funds or other deep horizon investors, the interim beta doesn't matter as to them their investment is crystallised for the next 5-10 year period. Investors who thus have a fundamentally conservative outlook on financial markets (those who believe markets are always correct in the long term), combined with those who think that income is a safer capital growth stream than price increases, are likely to flock to dividend stocks. Correct?

Well, in theory there are multiple drivers which determine where liquidity is directed. A massive contributor is government interference into market forces.
On the 6th of April, new taxation laws will come into effect, meaning that the top 1% of income earners (150k+ total comp) will be subjected to a wealth destroying, punitive income taxation rate of 50% over and above other taxes. What effect will this have on investment patterns? There are two factors

1. Income from dividends that is taken out as income is considered "income" for taxation purposes, and will be hit by the 50% income tax. This means that the effective rate of taxation upon dividends will come to 42.5% after deductibles.

2. Capital gains are only levied on realised profits from capital growth. And even then, the rate of the levy is 18%, with the first 10k being tax free.

Thus as we see dividend payouts being increasingly costly post 6th April, we must question which investor/ manager would be happy with returns that are instantly 10% lower post-tax? The tax bracket being hit by the chancellor and PM are overwhelmingly the upper-middle "investor" classes, who have a vast influence on stock beta due to active investment decisions either via brokers or wealth managers. Thus the effects of their liquidity directions could spark off a new trend.

Under this path of thinking, liquidity would be siphoned out of income stocks and into growth stocks. Since income stocks are a fundamentally long-term play, it stands to reason that depressed asset prices will continue in perpetuity, or until a change in the tax regime. If this occurs, the prominence that investors and companies pay to dividends may diminish rapidly. A focus on stock price growth could factor in capital reserves under book value, or the capital saved from nonpayment of dividends could be used to expand the business and thus rally security prices. Perhaps, in time, dividends will become a thing of the past.

NB This logic applied primarily to UK LSE listed securities. The effect on global equity markets is speculated to be minimal.

1 comment posted so far
Chaiwalla, Pankhawala, Chuthwala Singh Sodhi wrote at 8:54 pm on Tue 2nd Mar -
Can I add something to this post? Here it is:


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