Wall Street week ahead: Tax-loss selling to pressure 2017's losers in December

Stocks that have been lacklustre so far in 2017 are unlikely to see their fortunes reversed in the final month of the year, as investors engage in tax-harvesting practices before the new year. Investors often exercise tax-loss selling strategies, dumping stocks that have performed poorly in order to reduce or eliminate capital gains taxes, as the year draws to a close.
"This is something we do every December, we take losses for clients who we've created gains for," said Jake Dollarhide, chief executive officer of Longbow Asset Management in Tulsa, Oklahoma.
"Your clients want their cake and they want to eat it too - so they want to see an 8 to 12 percent return in any given year and they'd like to also not have to pay capital gains taxes." Tax overhaul negotiations in Washington have also added a potential wrinkle this year, as investors may wait until a clearer picture emerges. An investor seeking to divest a stock from their portfolio may hold off until January to delay paying taxes until the following year.
"There are a lot of people waiting on tax reform to make those decisions," said Ken Polcari, director of the NYSE floor division at O'Neil Securities in New York.
Stocks that were among the worst performing on the benchmark S&P 500 index in 2016 saw losses mount in the final month of that year. TripAdvisor fell 4 percent in December before closing the year with a loss of nearly 46 percent. Vertex Pharmaceuticals dropped nearly 10 percent for the month to close out the year with a decline of 41.5 percent.
That selling has often led to what is referred to by market participants as the "January effect," when stocks, particularly smallcap names, that may have been sold in December for tax harvesting, experience a rebound the following month.
Investors are prevented from selling shares for tax harvesting purposes and buying them, or shares in a similar stock, within 30 days by an Internal Revenue Service regulation against what is known as a "wash sale." That wait period helps create a lag before the beaten-down stocks rebound.
However, identifying stocks that may be potential buying opportunities because of tax harvesting strategies has become more difficult.
Many mutual funds share a fiscal year-end date at the conclusion of October and may start to sell for tax purposes in September. In addition, investors have become attuned to the practice and no longer limit the selling to December.
"Tax loss selling is like holiday shopping, it happens earlier and earlier every year," said Nicholas Colas, co-founder at DataTrek Research in New York.
At the start of 2017, TripAdvisor bounced back with a 14.1 percent rally for January, and Vertex surged 16.6 percent compared with the 1.8 percent S&P 500 gain for the month.
Among smallcap names, Mirati Therapeutics tumbled 11.2 percent in December 2016 en route to a drop of about 85 percent for the year. The stock rebounded sharply at the start of 2017, with a jump of over 7 percent in January.
Among the worst performers for the year on the S&P 500, Under Armour and Range Resources have slumped more than 50 percent, while Signet Jewelers and General Electric have lost more than 40 percent. On a sector basis, energy has struggled across the market cap spectrum for the year.
Further complicating matters this year was the strong performance registered by equities in September and October.
While those two months are historically a difficult time for the stock market, the S&P 500 rose roughly 2 percent in September and October, while the smallcap Russell 2000 index jumped 6 percent in September and tacked on another 0.8 percent in October.
"This year, we had pretty good performance in September and October," said Steve DeSanctis, equity strategist at Jefferies in New York. "Now it is up to other things like tax that is going to be more of a driver."