Tax Loss Selling/Year-End Bounce

Year End Bounce

Each calendar year around year end becomes bargain hunting season. Holiday shoppers flock to the malls and their favorite websites, and savvy investors search the stock market for year-end discounts. While our approach at The Turnaround Letter is heavily focused on long-term business fundamentals and underlying valuations, even we can be tempted by unusual short-term opportunities at year-end created by artificial selling pressure as investors toss their losers.

One source of selling pressure is the tax code. By selling losers, investors can generate taxable losses to offset other gains, saving on tax payments. Year-to-date, only about 12% of stocks in the S&P 500 have produced losses greater than 10%, and so the opportunity for unloading big losers is concentrated in just a handful of stocks.

Professional investors, often holders of large stakes in public companies, don’t want to spend January explaining to clients and consultants why they owned some big losers. It’s much easier to do some “portfolio window dressing” – removing them from their published annual reports by selling them prior to year-end. This tends to push down further the prices of already weak stocks.

Once the calendar turns to January 1st, these artificial pressures end. Many of the prior year’s worst performers bounce upward, sometimes sharply, early in the new year. Eventually, the longer term fundamentals and valuations take over, but nimble investors can capture some of the bounce. In some cases, the artificial selling offers a discounted entry point into an attractive longer term investment.

Not every year produces a January bounce. And sometimes a little extra patience is required. For example, this past year the S&P 500 lost 5.1% in January and another 4.1% in February, and so you had to wait until March for much of a bounce. But it did eventually occur. Of the ten bounce candidates highlighted in the December 2015 issue, eight of them were up nicely by March 31, and the whole group of ten produced an average gain of 16.4% versus a 1.0% loss for the S&P over that time period.

The stocks discussed in our December 2016 Turnaround Letter have some of the worst 2016 returns in the S&P 500. Not surprisingly, 12 of the worst 25 names are in the pharmaceutical/biotech/drug distribution industries, as this group was plagued by overvaluation, heightened product pricing pressure and regulatory concerns. From this group we chose Allergan. The other names below represent a diversified roster of promising bounce candidates.

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