WALL STREET Modest market advance follows dividend tax cut

Analysts say that in the long term, the impact might be far-reaching.
NEW YORK (AP) -- 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 & amp; 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."
What happens later?
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, though 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 increases pressure bond prices, analysts say.
Overall muted response
Still, the stock market's overall response to the tax cut was muted this past week.
For example, on May 22, the day Bush said he would sign the bill Congress had passed, the Dow Jones industrials had a modest 77 point gain, and the gauge posted a losing week. And on Wednesday, when the bill was signed, the Dow edged up just 11 points.
Analysts say many investors had expected some kind of dividend tax cut earlier in the year and scooped up stocks then. In addition, they note that sectors traditionally known for their high dividends, such as utilities, financial services and telecom, have surged in recent weeks.
The Dow Jones utilities average, for example, has gained about 4 percent in the past two weeks on the news, double the advance of the Standard & amp; Poor's 500 index. And so far this year, utilities stocks are up about 13 percent, compared with the S & amp;P's 9 percent advance.
Other individual stocks have also benefited. Half of the top 10 companies with market capitalization of more than $1 million that paid the highest dividends have enjoyed double-digit gains so far this year.
They include top dividend-paying company Instrumentarium, which pays a yield of 12.6 percent, and South American soft-drink company Embotelladora Andina, with a 11.4 percent yield. However, R.J. Reynolds had a double-digit loss despite its 11.2 percent yield.
Check prospects
Analysts caution against investors' focusing too much on stocks with the highest dividend. Particularly as many believe the economy begins to rebound, investors shouldn't forget companies with more modest yields that have good growth prospects.
"In the end, the dividend matters, but the ability to grow the dividend is just as important. You have to look for a company that's looking to grow," said Doug Sandler, chief equity strategist at Wachovia Securities.