As measured by the S&P 500 Index, U.S. stocks have posted impressive gains in 2019, up by more than 22% so far this year. A likely effect is that the remaining two months of 2019 will see a major wave of tax-loss selling as investors with realized capital gains sell their losing positions to reduce their capital gains tax liabilities for the year. This wave of selling, in turn, may create bargains for savvy investors, as the prices of these losing stocks are pushed down yet more.
To that end, veteran market watcher Mark Hulbert screened the S&P 1500 Index to find stocks that simultaneously are down significantly in 2019, but which have solid upside potential. Among the stocks on his list are these 10, per his column in Barron's, along with their YTD losses through the close on Oct. 31: Chesapeake Energy Corp. (CHK), -36%, GameStop Corp. (GME), -57%, Gap Inc. (GPS), -37%, Macy’s Inc. (M), -49%, Goodyear Tire & Rubber Co. (GT), -22%, Halliburton Co. (HAL), -28%, L Brands Inc. (LB), -34%, Meredith Corp. (MDP), -27%, iRobot Corp. (IRBT), -43%, and The Mosaic Co. (MOS), -32%.
KEY TAKEAWAYS
- Tax-loss selling tends to further depress the prices of losing stocks.
- These stocks thus can become bargains that rebound in the next year.
- However, investors must be choosy about beaten-down stocks.
- Tax-loss selling itself has many complications and pitfalls.
Significance for Investors
Hulbert used a database from 1926 onwards that is maintained by professors Eugene Fama of the University of Chicago, a Nobel Prize winner, and Ken French of Dartmouth College. From that database, he constructed a hypothetical portfolio that, in each month, held the 10% of stocks with the worst returns during the preceding 12 months.
Hulbert found that the average monthly returns of this portfolio were 1.3%, 0.3%, and 0.2%, respectively, during each of the first three quarters of the year. In the final quarter, the average monthly return was a loss of 0.5%. He attributes the especially poor 4Q performance to a combination of tax loss selling and so-called window dressing, by which fund managers sell losers to keep them off their year-end portfolio reports.
To uncover potential bargain stocks right now based on these findings, Hulbert first identified the worst-performing 10% of stocks in the broad S&P 1500 Index for the year-to-date through Oct. 25, a group of 150 stocks. Noting that "it’s important to be choosy and not indiscriminately buy just any stock that has performed dismally," he then selected just those stocks that have been recommended by at least one, and preferably more, of the top-performing investment newsletters that he monitors. He eventually came up with 17 promising stocks, of which 10 are presented above.
Meanwhile, investors who plan to engage in tax-loss selling should not always wait until December, argues a column in The Wall Street Journal. A key consideration is your holding period. If waiting until December converts a short-term loss (asset held less than a year) into a long-term loss (asset held for at least one year), the potential federal tax benefit from the loss declines.
For investors who are inclined to heed this advice and sell losers early, a critical unknown is how the stock will perform between then and year-end. If it rises, the tax loss will decrease or even disappear, but the after-tax value of your portfolio probably will be higher. If it falls, the opposite is likely to be true.
Tax-loss selling, also called tax-loss harvesting, has sparked a boom in robo-advisors that offer automated advice on when to book losses, the Journal reports. Critics say that these programs often overstate the potential benefits, such as by assuming that the client is in one of the highest federal tax brackets and lives in a high tax state. Another complication is that some high-tax states, notably New Jersey, do not allow tax losses to be carried forward into future years, a critical wrinkle that these programs may ignore.
Looking Ahead
Regarding the potential bargain stocks that may be created by tax-loss selling, it is worth emphasizing the old securities industry caveat that past performance is no guarantee of future results. With respect to tax-loss selling itself, too many investors make suboptimal decisions based on a desire to minimize taxes. Since taxes take away only part of your gains and offset only part of your losses, it generally makes sense to maximize gains and minimize losses.
