I think the calendar will call the shots in the stock market for the next four to six weeks.
And that’s why I think momentum has shifted toward sellers rather than buyers.
I know that today’s drop–the Standard & Poor’s 500 closed down 1.86% and the Dow Jones Industrial Average was lower by 2.29%–got billed as selling because the market is worried about the upsurge in coronavirus cases as we head into winter.
But I’d note that worries about the winter’s big increase in coronavirus infections has been around for weeks now. And the market has been holding its own–if not exactly racing higher–after the early September highs.
What has changed, in my opinion, is that the calendar has flipped over a few more pages and we’re at the beginning for the season of tax-loss selling and profit-taking before the end of the year and the shadow of higher capital gains taxes under a potential Biden administration.
Let’s take tax-loss selling first since it comes every year around this time and is very easy to understand.
If you have big profits this year, say you owned Apple (AAPL), up 58% in 2020 but sold it recently when you thought the shares had peaked, you’d love to offset some of the taxes on those gains with losses from your portfolio. The rules say that you have to realize those losses before the end of the year and that you have to wait 30 days before rebuying the stock, ETF or mutual fund that you sold, or buying a “substantially identical” asset. Many institutional money managers with fiscal years that end before December 31 begin selling earlier–before October 31 in many cases for mutual funds. Historically what this tax-loss harvesting does is to put downward pressure on stocks that are underwater for the year (or recently) as investors who want to offset gains sell those losing positions. A stock like Intel (INTC), for example, which is down 19.7% for the last three months and down 17.8% for 2020 as of October 26, 2020, is likely to see selling by investors who want to harvest tax losses to offset gains. That selling will be concentrated in the period before the end of 2020. And it will come no matter what the long term prospects for the stock might be. Remember an investor can reverse that sell with a buy after 30 days. Or they can reverse the sell of Intel by buying another chip stock such as Advanced Micro Devices (AMD) or Taiwan Semiconductor Manufacturing (TSM.) By the way, year-end tax loss selling is one cause of the January effect that in many years pushes the market higher in December and January.
This year, though, the downward pressure of tax-loss selling on stocks with losses in 2020 looks like it will be re-enforced by selling of winners as investors and traders decide to take profits.
Why would someone want to take profits in an Amazon (AMZN), for example? The stock is up 73% for 2020 through the close on October 26. But the stock is, by Morningstar’s calculations, still only at fair value after that climb. Amazon’s cloud business continues to grow at a breakneck rate (and the company is #1 in the segment.) The company was the big winner from the growth of on-line commerce before the pandemic and Amazon has reaped the benefit from a big shift to on-line buying during the coronavirus pandemic.
But you might want to sell if you think Joe Biden will win his presidential race against Donald Trump and that the Democrats will take control of the Senate too. Biden has proposed raising the tax on capital gains–exactly the tax an investor or trader pays on profits from a stock–to 39.1%, the same as the top rate on regular income that Biden has proposed, for households with more than $1 million in income. The current capital gains rate is 20% for households with incomes above $441,451.
It’s not likely that even in the case of a Democratic sweep that Biden could get these tax rates made into law before, say the middle of 2021 or early 2022, but Wall Street knows that tax increases are sometimes retroactive. I’ve read commentary from Wall Street money managers and former Federal Reserve officials warning that tax increases will be retroactive and the only way to escape them will be to take profits in 2020. Some of the remarks I’ve read are already partway down the road to the usual tax hysteria of the money class and that’s even before the November 3 election has been run. If Biden wins, I’d expect more voices on Wall Street to join in the yelling.
Enough to create significant selling among the winning stocks of 2020? I don’t know, but the urge to take profits is always ready to spur action on any signs of market distress.
Add these structure reasons to sell to any negative news from the coronavirus or the U.S. economy in weighing how momentum to buy balances out with momentum to sell.