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The 0% dividend tax rate--the centerpiece of the growth program that President George W. Bush unveiled this week--is going to be the biggest event for U.S. asset markets since the Reagan tax cuts. A dividend tax cut will raise the after-tax return on dividend-paying assets above other assets. Investors will shift portfolios, driving dividend-paying asset prices up. The intrinsic value of the S&P 900 will rise by 8.5%, increasing net worth by $799 billion, with the biggest increases in industrials ($225 billion), consumer discretionary ($202 billion), telecom ($132 billion) and health care ($108 billion). There are huge further gains for companies that increase dividends and reduce debt. Effects vary widely by sector, as shown below. The biggest effects will occur in sectors with high dividend-payout ratios and little debt. In the telecom sector, for example, the tax cut would increase equity value by 33.4%. Preferred stocks with high dividend yields are a very efficient way to place a bet on the initial gains on dividend-paying stocks. Convertible preferred stock issued by companies with low common-stock-payout ratios (therefore, big upside from strategy change) are also attractive. Common stocks of companies or industries with big dividend-payout ratios--such as Verizon Communications (nyse: VZ - news - people ), SBC Communications (nyse: SBC - news - people ) and Bristol-Myers Squibb (nyse: BMY - news - people )--are also an attractive way to benefit from the initial price increase. The subsequent gains will accrue to companies or industries with flexibility to increase payout rates, pay meaningful special dividends or refinance capital structure. This is only the beginning. Managers will adapt to the new tax regime by increasing dividend payouts and reducing debt. Both will increase stock prices. This could add 5% or more per year to total returns for several years as companies adjust to new tax rates. Watch out for real estate investment trusts, or REITs, and master limited partnerships, or MLPs. They have high dividend yields but could be singled out for exclusion from the benefits of the tax cut because they already have special tax status, which allows them to avoid double taxation, similar to S Corporations. If they get the lower tax rate, they will be wonderful investments. It they are singled out for exclusion, however, income-seeking investors will sell them to buy other securities. Treasury bonds, along with other fixed-income securities, are clear losers, as we warned last week. In the past year, investors have parked tons of money in Treasuries and bond funds, waiting for a better day. If the dividend tax cut ushers in that better day, as I believe it will, bond yields will rise and bond prices will fall substantially. Hard assets that pay no dividends, such as land, commodities and precious metals, will be hurt as investors shift from hard assets, which pay no dividends, to dividend-paying securities. The dividend tax cut will put downward pressure on goods prices and inflation rates.
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