Closing Market Report

Star-Bulletin news services

Stock’s reaction to tax
cut modest, but impact
may be far-reaching

NEW YORK >> After President Bush signed the dividend tax cut into law this past week, Wall Street staged only a modest advance. That might have disappointed some market observers who expected stocks to have a more dramatic response.

Analysts say that isn't entirely surprising since many dividend stocks already surged in anticipation of a tax cut. The longer-term impact, they say, may be more far-reaching, with greater incentives for investors to shun bonds and follow a less risky buy-and-hold strategy.

"One of the nice positives of this is there is a very wide spread between long-term and short-term tax rates," said Joseph Lisanti, editor of Standard & Poor's weekly newsletter The Outlook.

"So if you were churning (your portfolio) and make a profit ...the ideal situation is to hold your equities for longer than a year," he said. "Longer-term holdings would be great for the stock market because there would be more stability."

Under the new law, the tax rate on dividends and long-term capital gains is reduced to 15 percent for the next five years. It is unclear what will happen after the reduction expires in 2009, although many believe the cut would be politically difficult to completely rescind once taxpayers enjoy the benefit.

Previously, capital gains on investments held for more than one year were taxed at 20 percent, while dividends were taxed as ordinary income at federal tax rates as high as 38.6 percent.

Meanwhile, interest payments on bonds will continue to be taxed as ordinary income. That offers investors another reason to re-examine their bond holdings particularly as the threat of interest rate hikes pressure bond prices, analysts say.

Still, the stock market's overall response to the tax cut was muted this past week. For example, on Wednesday, when the tax bill was signed, the Dow edged up just 11 points.

For the week, the Dow rose 248.88, or 2.9 percent. It closed yesterday at 8,850.26.

The Nasdaq had a weekly advance of 85.82, or 5.7 percent, closing at 1,595.91 yesterday.

For the week, the Standard & Poor's 500 index rose 30.37, or 3.3 percent, to finish at 963.59.

The Russell 2000 index, the barometer of smaller company stocks, had a weekly gain of 22.60, or 5.4 percent, closing at 441.00.

The Wilshire 5000 Total Market Index, which tracks more than 5,700 U.S.-based companies, ended the week at 9,218.89, up 140.78. A year ago, the index was at 10,106.49.

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