With the year winding down, Mark Hulbert says history indicates it’s almost time for small-cap stocks to outperform their larger peers.
The reason: tax-loss selling (that is, when investors sell losing positions to offset capital gains or other income for the year, thereby lowering their taxable income). In his MarketWatch column, Hulbert says tax-loss selling most often impacts smaller stocks, because large stocks are predominantly purchased “by large institutional investors, many of which operate on different taxable years or which are tax exempt.” Smaller stocks, meanwhile, tend to be bought by retail investors. “And it doesn’t take much of a shift in the behavior of such investors to influence the prices of such stocks,” Hulbert writes, “causing them to fall more than the rest of the market as year-end approaches, and then to rise more than the market during January, once tax-loss selling has abated.”
This time, Hulbert says history indicates the bump small stocks will get following the tax-loss selling will be “somewhat less pronounced than usual”. After studying data that goes back to the mid-1920s, Hulbert found the tax-loss selling effect tends to be greatest coming off of big down years for the market. “This makes sense, of course, since without widespread losses that investors can harvest for tax purposes one would expect tax loss selling to have a lesser impact,” he writes.
But Hulbert says that doesn’t mean the tax-loss effect won’t have an impact on stocks. He says it’s “likely to be concentrated in the very smallest companies, whose trading is most sensitive to slight changes in investor behavior.” And he offers some picks from that group.
Hulbert says stocks like these should be particularly vulnerable to declines in the first couple weeks of December, “in the process falling to low prices at which traders could buy in anticipation of a bounce around year-end.”