Add to Holdings of Domestic Stocks

The market's recent weakness presents a buying opportunity, in S&P's view, and it recommends moving 5% from cash into domestic equities

By Joseph Lisanti

We believe stocks are likely to resume their upward trend once the market's near-term uncertainty is out of the way, and Standard & Poor's now recommends an allocation of 55% U.S. stocks, 15% foreign stocks, 10% bonds and 20% cash.

One reason for this optimism is that market rallies rarely flare out this quickly. The second year of a market rally is generally a good one for large-cap stocks, and large-caps tend to correlate with the shares that pay dividends. Thanks to last year's reduction in the tax rate on dividends, 2004 is shaping up to be a good year for dividend-paying stocks.

David Wyss, chief economist at S&P, expects that the lower tax rates for dividends and capital gains will lead to a large increase in refunds sent by the IRS this year. Overall, he estimates tax refunds for 2004 will total about $250 billion, or roughly $50 billion more than in 2003. While some of that rise can be credited to economic growth, the more important factors will be the increased child care allowance and the tax cuts for dividend and capital gains income.

Howard Silverblatt of S&P Quantitative Services says that since the tax cut was enacted, dividend payouts have been on an unmistakable upward trend. A disproportionately large number of dividend increases get made early in the year, when companies want to put shareholders in a good mood before their annual meetings. Through Mar. 18, there were 86 dividend increases for stocks in the S&P 500 vs. 67 for the first three months of 2003.

Perhaps the best news is that the favorable trends for dividends may be here to stay. Whoever wins the presidency, we believe that political realities will dictate that the dividend tax cut won't be erased anytime soon.

This will leave several billion extra dollars in the hands of taxpayers each year, and we believe some of this money will get steered back into the market and contribute to higher stock prices.

Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook

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