Could battered U.S. stocks, a tax-loss selling favourite, come back in January?

Investors who sell failing American stocks to lock in tax savings could be adding to current market pressure

Could battered U.S. stocks, a tax-loss selling favourite, come back in January?

By selling underperforming U.S. companies, investors looking to reap tax benefits may be adding to market pressure on stocks while also laying the groundwork for a January comeback in some parts of the market.

Tax-loss harvesting, the practice of selling assets at a loss to offset income taxes owed on realized gains elsewhere in an investor’s portfolio, may be a stronger than usual headwind for markets this year. The S&P 500 has declined by about 16% year to date, and many individual stocks have sunk even further.

“This is the first time that investors are looking at double-digit declines in about 13 years, and we’ve never seen this level of tax-loss selling before,” Peter Essele, who oversees roughly US$11 billion as in assets as head of portfolio management for Commonwealth Financial Network, told Reuters. “That could result in a pretty strong first couple of months as people start reentering long-term assets.”

According to analysts at BofA Global Research, S&P 500 equities that are down 10% or more for the year have traditionally outperformed the wider index between November and the end of January during years in which the index lost more than 10%. This makes them plausible targets for tax-loss selling.

Meta Platforms Inc, Domino's Pizza Inc, Home Depot Inc, and Inc. were among the 159 companies out of 338 in the S&P 500 with annual losses of 10% or more that the firm recognized as having potential to recover after tax selling.

Each company's shares are down 1% or more for the month of December, with Amazon leading the pack with a drop of about 8%.

The founder of DoubleLine, Jeffrey Gundlach, stated on CNBC on Wednesday that risk assets will probably rebound in January once ordinary investors have finished selling their tax losses.

In a report published on November 30, Evercore strategists stated that they were "purchasers of equities whose 2022 Tax Loss selling pressure will soon abate."

In a research note published in late November, retail trader tracking firm Vanda Research stated that during the final weeks of December, individual investors typically withdraw an average of US$1 billion on net from shares of individual U.S. stocks and invest those funds in ETFs that provide exposure to wider markets, thereby assisting so-called "Santa Claus rallies" at the end of the year.

According to Emily Rowland, co-chief investment strategist at John Hancock Investment Management, macroeconomic issues like monetary policy and worries about a potential recession brought on by the Federal Reserve's swift interest rate increases are obviously likely to continue to dominate stock market movements in 2023, potentially outweighing the influence of seasonal flows.

Read more: Can seasonality help you anticipate the stock market?