Market Ethos
December 9, 2024
Tax loss selling: Not a lot on the naughty list
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Summary: Tax loss selling at this time of year can often lead to weakness in beaten down names that rebound in January as investors re-purchase after waiting the required time. However, this year may be the opposite given how few tax loss candidates are available and the strong gains markets enjoyed over the past couple years. More investors may be waiting to realize those great gains in the new year, pushing out the tax bill another year.
It’s that time of year, when people think a little bit more about nice gifts for their loved ones … and tax loss selling. Tax loss selling is common for those who own individual stock positions. Find names that have declined on the year relative to your cost base, or are sitting with an unrealized capital loss, and sell them. Realize the loss to offset gains elsewhere or put it in the bank for future gains. The company sold can perhaps be repurchased after waiting the appropriate amount of time.
So why is this a bizarre year? Well, markets have really enjoyed a strong couple of years which has made tax loss-selling candidates few and far between. We conducted this analysis over the past seven years and looked at how many members of the TSX were down over -20% near year-end compared to their average price over the previous three years (names are included below). Down a lot from your three-year average would certainly make for a good tax loss-selling candidate. Today there are only 19 names that are down over -20% (purple bars in chart), and the decline is not as severe as most other years (black triangle). That is the lowest showing since 2021. This year is really starting to look more and more like 2021.
That isn’t the only reason this year appears a bit strange. The average size or market capitalization of tax loss candidates tends to be on the smaller size. Over the previous six years, the company size averaged about $3.4 billion. This year, it is a much larger sample with the average size $6.7 billion. BCE and Nutrien are skewing the average much higher than normal. The sector breakdown is very different as well. Tax loss selling candidates tend to be most prevalent in the resource space, energy and materials. This year, fewer names from on the resource side and more from Telecom, Consumer Discretionary and Real Estate.
Tax loss selling does create some added selling pressure on tax loss selling candidate names as the calendar year nears its end. And subsequently, assuming investors re-purchase early in the new year, some buying pressure in January. This contributes to the January effect, that is usually more prevalent for small cap names (as they tend to get pushed around more by buying/selling pressure due to being less liquid).
However, this year may be a unique one. Given markets have largely gone up over the past couple years, tax loss selling just isn’t as big a factor this year. In fact, there may be more folks waiting to sell in the new year to lock in some of those great gains over the past year – and by doing so, delay the tax bill until the 2025 taxation year (payable in 2026 for most). This year it may be more about the delay of realizing tax gains vs tax loss selling.
One thing we have learned over the years is that markets often move faster and sooner than one would normally expect. Maybe there are many people coming to the conclusion that January could see selling pressure as investors lock in some of the great gains over the past few years, and finding ways to do it sooner. Selling in tax free accounts, using options/derivatives to effectuate the strategy without triggering the capital gains. Hard to say, but we have started to see an odd development even for the mighty S&P 500. Breadth has been deteriorating rather quickly while the market makes new highs.
Only 34% of the S&P 500 constituents are trading above their 10-day moving average. Now 10 days is not very long but the 20-day is falling fast too and the longer time periods appear to be rolling over. Eroding market breadth with an index sitting at all-time highs is not encouraging. Maybe it is time to think about locking in some of those fantastic gains over the past few years and looking for a better entry point, especially if one develops in January.
