‘Tis the season for tax-loss selling. When good investors go to sleep with visions of taking losses to offset profits dancing in their heads.
Investors sell losing stocks in November and December in order to generate tax deductions they can use to offset profits earned during the year. And historically that end of the year selling helps power what’s known as the January effect as investors with cash from their December disposals step in to buy bargains created by that end of the year selling.
I’d imagine that both the tax-loss-selling and the January bargain hunting are going to be the same but very different this year. It’s not often that investors go into December looking back at both a 64% gain in the Standard & Poor’s 500 (from the March 9, 2009 bottom) and a 53% loss in the 14-plus months (from January 1, 2008 to that March 9 2009 bottom).
In other words investors have plenty of profits to offset—from 2009—and lots and lots of candidates to sell from 2008-2009.
My guess, and it’s really no more or less than an educated read on investor psychology, is that the selling will be especially heavy in those stocks that have under-performed during the rally. No one really wants to sell a great recent performer at a loss. The impulse, research into investor behavior shows, is to hold it until the position breaks even.
But wait, we’ve had a huge rally. Can’t be many stocks down for the year, right?
Wrong.
If you’ve been mesmerized by the rally, you’ve probably lost sight of exactly how many stocks are still down for the year. According to Morningstar, 3,191 stocks are down 10% or more for 2009, when the S&P as a whole is up 16%. (That’s out of almost 10,200 stocks in Morningstar’s data base.)
2481 stocks are down 25% or more for the year.
And 1527 are down 50% or more for 2009.
That group isn’t equally distributed across the stock market.
By far the largest group, 225 out of that 1527, are regional banks. That’s 15%. A shockingly large number even if you know the huge portfolios of troubled commercial and commercial real estate loans regional banks are still carrying.
Certainly that argues that regional bank stocks will be under strong end of the year tax-loss selling pressure this year.
But the well-publicized problems in this sector make it unlikely that these stocks will bounce back with any January effect this year.
End of the year tax loss selling is the least of this sector’s problems.
I suspect that tax-loss selling will be muted this year because for many investors, their big losses from 2008 will easily swamp any gains they have from 2009 trades. The broad indices have only retraced about 50% of their October 2007 to March 2009 losses. I suspect many investors who trade fairly frequently will have carry-forward losses already, without needing to realize more in late 2009 to avoid capital gains taxes. In fact, some may want to sell some winners to help consume some of those carry-forward losses, since individuals can only write off a max of $3k in past losses against ordinary income each year.
Jim,
Great article! I really appreciate your insight. I’m somewhat split on the tax-loss selling with CEDC… They just issued shares for acquisition…. Interesting timing. What are your thoughts?
Great Post Jim! I’m enjoying the tax loss selling with some buying of some financially sound regional banks like UBSI, LKFN, and HCBK over the past few weeks. I’m enjoying great dividends while these quality banks buy failed bank assets on the cheap and grow. I am prepared to wait 2-3 years for my capital gains. More risky banks like SNV and ZION I am playing the short-term rallies with call options.