Friday, December 25, 2009

Year-End Portfolio Games

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

As we approach year-end, there are always "tricks and games" to be aware of in the financial markets as traders and portfolio managers square up their books and close the year early or use the lull in liquidity to play some games that ordinarily wouldn't fly.

Tax loss selling is common among investors this time of year (and during the fourth quarter as a whole) as they seek to sell losing positions for the potential tax write off or equal out winners and losers. This is usually more pronounced when the market has had a September/October correction or has been in a downtrend for most of the year. Typically, the worse a stock has performed and the more widely held, the more susceptible it becomes to tax loss selling.

What's different this year is that we all know the capital gains tax will be rising in the years ahead, whether that begins at some point in 2010 or for the start of 2011. So some investors are seeking to take whatever gains they have in 2009 for a known tax rate versus waiting until next year with uncertainty.

The January Effect is also a popular short-term trading strategy this time of year. It can be interpreted two ways. One is that small cap stocks tend to outperform their large cap brethren in January. Taking advantage of this can easily be accomplished by either buying a small cap index ETF or mutual fund. Additionally, a bit more complex, an investor can buy the aforementioned ETF or mutual fund and sell short an equal amount of a large cap index ETF or mutual fund.

The other January Effect trade involves buying beaten down stocks in mid December that make new 52 week lows in the fourth quarter, i.e. great tax loss selling candidates! Besides individuals selling them for tax reasons, institutions like mutual funds, pensions and even hedge funds do the same, but also do not want to show these disasters on their year-end reports to investors if they disclose their holdings.

The key here is to make sure the stocks trade enough volume that the institutional players will be able to buy them in early January when they have plenty of time to reward them, as well as confirming each company has sufficient cash to last them well into 2010. Stocks get beaten down for a reason, so the significant cash position will hopefully keep them in business, at least during the trade. This trend typically performs better with either a September/October market correction or downtrend lasting most of the year.

Finally, the January Barometer, made famous by Yale Hirsch of Stock Traders Almanac fame, simply says as goes the month of January, so goes the whole year. Over the years, Yale and his son Jeff also created the early warning January Barometer, which says as goes the first five trading days of the year, so goes the rest of the year. You can learn more by Googleing or buying their book from Amazon.

Stocks are now in an extremely bullish time of year. Depending on which index you use and what time period, the stock market has a roughly 75% chance of heading higher during the last 10 trading days of the year. Conspiracy theorists would argue that the decline we saw last week was nothing more than manipulation to allow smart money to buy stocks at cheaper levels for an easy trade.

While I don't buy it, that would be interesting to see the market close at its low last week and then head sharply higher to the end of the year. We'll see, but that coincidence would be "curious".

Whatever holiday you celebrated, I hope it was enjoyable, peaceful and safe!

Please feel free to email me with any questions or comments at

Until next time…

Paul Schatz

1 comment:

  1. So what you're saying is...your guess is as good as mine.