Unexpectedly Intriguing!
October 4, 2010

Now that we've entered a new business quarter, it's time to look ahead at what investors currently expect for the economic situation in the United States through the end of 2011.

S&P 500 Expected Trailing Year Dividends Per Share (Historic and Futures Data) As Of 04 October 2010 We'll do that using dividend futures data for the S&P 500, where we can get a good sense of how good investors expect each quarter between now and the fourth quarter of 2011 will play out by size of the gaps between each quarter's projected trailing year dividend data.

What we find is that investors expect very little in the way of economic growth in the fourth quarter of 2011. That would appear to be followed by a major economic boom in the first quarter of 2011, followed by a very sluggish second quarter, before growth would seem to pick up again in the third and fourth quarters of the year.

The problem we see in looking at what investors expect for the future is the major economic boom that would appear to be in store for 2011-Q1.

One observation we need to make right off the bat involves the time mismatch between a quarter represented by dividend futures contracts and a calendar business quarter. Here, there is often anywhere from 12-15 days that elapse from the time a dividend futures contract expires and the end of a calendar business quarter.

That's a significant factor for when we look forward to the first quarter of 2011, where we see that the U.S. economy would appear to be in for a booming quarter. Unfortunately, there are other factors at play that would make that outcome very unlikely.

What we suspect is that businesses will be paying out much larger cash dividends to their shareholders during the final 15 calendar days of 2010 than they would have done otherwise, thanks to the continuing uncertainty related to how much dividends will be taxed in 2011.

With the U.S. Congress having adjourned until November 2010 without having taken any action to deal with tax rates in 2011, investors face three possible scenario where dividends are concerned:

  1. The Congress will take no action to prevent the expiration of the Bush era's dividend tax rates, which will increase to be the same as the tax rate that applies to the investor's ordinary income from 0% for investors whose total income would place them in the 10% or 15% marginal income tax brackets and 15% for all other investors.
  2. The Congress will act to increase the dividend tax rate to 15% for individuals with incomes that place them in the 10% and 15% marginal tax brackets, but will increase to 20% for all other investors, as President Obama desires. Speaking of those desires, we should note that income from dividends will be subject to additional taxes beginning in 2013 thanks to the recently passed health care law.
  3. The Congress will act to extend the Bush era law, keeping the tax rate on dividends at 0% for individuals with incomes that place them in the 10% and 15% tax brackets and 15% for all other investors.

S&P 500 Historic and Expected* Quarterly Dividends per Share, 2009Q1 Through 2011Q4, as of 4 October 2010 Looking at the expected future quarterly dividends per share that will be paid out through the end of 2011, it appears to us that the high level of dividends expected to be paid out in the first quarter of 2011 is most likely an anomaly, which we find is also supported by historical quarterly dividend data.

Consequently, we find that rather than enjoying a booming economy in the first quarter of 2011, the U.S. economy will continue its recent history of anemic growth during that quarter.

Speaking of which, we'll be officially projecting where GDP will be recorded for the third quarter of 2010 later this week.

Update 10:27 AM PDT: It suddenly occurred to us that if the trailing year dividend futures data we use to project where stock prices are going next are indeed being inflated by an investor game of "beat the clock" being played in the first quarter of 2011 (or rather, during the last two weeks of 2010), it may well be that the noise we've been seeing in the stock market since April 2010 may in fact be in the dividend data rather than in the price data!

If that's the case, stock prices will likely underperform our last forecast by a significant margin, since we assumed that the dividend data we used to make our projection was real and not being inflated above where expected future business conditions would otherwise put them!

It all just got a lot more interesting!

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