Yearly Archives: 2013

strategy for 2014: yearend tax selling

November 5, 2013 By in Current Market Thoughts, Portfolio management, selling a stock, Strategy, yearend tax selling Tags: , , , Leave a comment

I won’t be writing my strategy thoughts for 2014 for a few weeks.  However, it’s not too early for all of us to be thinking seriously about yearend tax selling, both as a market phenomenon and as a part of our personal portfolio management.

A disclaimer before I begin:  I’m an investor, not a CPA.  To get all the ins and outs of the capital gains tax rules, read the appropriate IRS or other tax authority publications.

why it happens

For most taxable investors in the US and mo,st other areas I’m aware of, the tax year ends with the calendar year on December 31st.  (One major exception is mutual funds and ETFs.  Their tax years generally end on October 31st–giving them time to close their books and make required distributions to their customers–who must pay tax on these receipts–before 12/31).

Investment gains are taxable once they’re “realized,” i.e., once the investment is sold.  But tax is due only on the net gain–that is, after subtracting any realized investment losses–not the gross amount.

In an ideal world, we’d all be doing tax planning constantly.  The reality is different.  Professionals believe (correctly, in my view) that taxes aren’t the most important elements of portfolio construction, so sometimes, in my attention, they pay shockingly little attention.  The rest of us just wait around until the end of the tax year approaches.

the phenomenon

For taxable professionals, like insurance companies or banks, who hold “balanced” portfolios of several asset classes (stocks, bonds, alternatives), they’ll try to match sales of, say, money-losing bonds and money-making stocks so that the net effect is zero taxable income.

Or it may be that guidelines, either internal or regulatory, require them to prune large winning bets.  In that case, they’ll scour the rest of the portfolio for anything with a loss attached to it and heave that overboard–just to knock down the tax bill.

This all occurs in the six-week period from early November to mid-December.  Clunkers may be sold more aggressively but there’s also downward pressure on winners as well.

For individuals, the main focus of selling tends to be small-cap names that have performed poorly.  They tend not to be sold with a very light touch.  Instead, individuals typically dump them out without much/any regard for price–just to get rid of them.  This sets the stage for the “January effect” as these beaten up stocks rebound after the first of the new year.

taking advantage

If the advent of tax season isn’t the reason for doing some serious thinking about what positions we want to take into 2014, it can at least be the occasion for doing so.  For example, serial clunkers in our portfolios tend to find ways to make our eyes skip over them when we examine our holdings.  It’s much harder for them to hide when we’re specifically looking for red ink to make use of

Similarly, we all love our big winners.  But we also have to .remember that at some point the risk of holding a (for us) humongous position outweighs the possible future gains.  Yearend is a good time to consider whether to trim.  Don’t be like a hapless acquaintance during the internet bubble who rode JDS Uniphase from $ 3 to $1000 (a position of $100,000 to $30 million) …and back down again.  Think Mark Cuban instead.

A more aggressive tactic would be to shop around for rebound candidates among this year’s big losers.  They may be pushed down by, say, another 10% before the year is out as holders shove them out the door to take tax losses.  This is not my style, so I have no words of advice, other than that you better do your homework before taking the plunge.

“wash” sales

One more point:  You can sell a position that’s deep in the red to recognize the loss and then buy it back.  But the IRS says you have to wait 30 days before the buyback to be able to take the loss.

I’m not a fan of the tactic, although some people may be able to do this successfully.  For me, it would be perpetuating the delusion that I haven’t made a mistake.

backing and filling

November 4, 2013 By in Current Market Thoughts, Portfolio management, Technical Analysis Tags: , , , , , , 1 Comment

Backing and filling is what I think the S&P is beginning to do now, and will continue to do–possibly through yearend.

What is it?

I decided to Google the term before I started writing but didn’t find anyplace that has the idea right.  I’m not sure why.  Maybe in “modern” technical analysis (an oxymoron on a par with jumbo shrimp) people use a different term.

Anyway,

the basic idea has two aspects:

1.  that there’s a normal or natural, relatively sedate, trend of upward progress in the stock market.  For the S&P, it’s probably 8%-10% a year.

2.  Sometimes, however, either the market as a whole or an individual stock will rocket upward in a very short period of time.  Like what AMZN and GOOG did last month.  Arguably, the S&P as a whole has done so in 2013 so far, considering that the index is up by about 25% since New Year’s Day.

When this happens, there’s a price to pay for the too-rapid movement.

The market/stock has to “digest” the gains, as they say.  It does so in one of two ways.

It can tread water for a period of time, establishing a “base” for further advance by recording significant volume at around the peak levels.

Or, more frequently, it will retreat somewhat from the peak, fill in the “missing” volume at somewhat lower levels and return to the peak from there.  There’s no hard and fast rule for how much the stock/market will go down during this process, but technicians typically make projections based on fractional parts of the advance.  The most common ones used–on all occasions–are 1/3, 1/2 or 2/3 of the just-completed upward move.

Either is backing and filling.

I don’t know where the term comes from, but I’ve always thought of backing and filling as a construction metaphor.  A bulldozer builds a pyramid of dirt.  If the pile gets too high–and too pointy at the top–the dozer has to flatten out and broaden the mound before it can build it higher.

There’s also a psychological basis for backing and filling.  Suppose you bought GOOG three or four weeks ago.  Today you have a 20%+ gain in a very short time.  So you’re tempted to take your profit and put the money to work elsewhere.  That’s where the selling comes from.

The buyer?  He’s the guy who regrets not purchasing the stock when you did.  He probably won’t pay $1000, but $975 may look like an incredible bargain to him.

So the security involved tos and fros until the temporary selling urge is satisfied.

my take

I’ve begun to notice this happening with the stronger performers in my portfolio.  I don’t think this is a worry.  It’s just the way the market works.  As one of my professors used to say, “You can’t have ice cream for every course of the meal.”  I have no idea why not, but that’s what he said.

more on reversion to the mean

October 31, 2013 By in book value, distressed assets, from growth to value: the life cycle, growth vs value, mean reversion, Portfolio management, Strategy, two flavors of value Tags: , , , , , , Leave a comment

Happy Halloween!!!  

Trick or Treating for all!!!

This is a continuation of my post from yesterday.

why value works less well today

I’m a growth investor by temperament.  But I’ve spent more than half of my working career as an analyst and portfolio manager in value shops.  My basic contention is that traditional value investing works much less well in a globalized and post-Internet world than it did previously.

Why do I think this?

One of the two basic premises of value investing is that a firm’s investment in plant, equipment, distribution networks and brand name have a value that is substantial and that endures despite current mismanagement or battering by the business cycle.  The Internet has upended a lot of this, and the ability to move production to the emerging world has done more.

(The second premise is that change of control–either though action by the board of directors or by outside influences–is possible.  True in the US, but very often not elsewhere.  Twenty five years of activist investor failure in Japan is the most notable example.  But continental Europe is just the same.)

flavors of value

I’ve written about this before.  Basically, some value investors buy stocks simply because they’re very cheap, period.  Others wait to identify a catalyst for change before they jump in.

Personally, I believe that in today’s world the latter is the far safer course.  Yes, you may miss the absolute bottom.  But you also have greater assurance that you’re not booking passage on a latter-day Flying Dutchman that is doomed to never go up.

growth and value cycles

Through most of my thirty years in the investment business, periods of value outperformance and growth supremacy were each relatively short and both contained within a four-year business cycle.  For the past fifteen years or so, the periods of one style or the other being in vogue have been much longer.  I don’t know why.  But this phenomenon may make slavish devotion to one style or the other riskier than it has been in the past.

Consumer Discretionary vs. Staples

Back to the uninformative Bloomberg discussion of Consumer Discretionary vs. Staples.  Is there anything to the idea that Staples may make a recovery vs. Consumer Discretionary?

Yes and no.

yes

I think conditions are beginning to come into place for Staples stocks in the US to begin to do well again.  Many Staples stocks have large international exposure, much of that in the EU.  Europe appears to finally have moved past the bottom of its Great Recession and to be beginning to recover.  So revenues for Staples companies there should begin to perk up.  More important, the euro has moved up by about 7% against the dollar since July.  So the dollar value of those recovering sales to a US firm with EU exposure will, I think, be surprisingly high.

It’s possible that a continuation of economy-damaging politics as usual in Washington will make even slow growth in the EU look relatively attractive.  A renewed global investor interest in Europe may well cause its currency to remain firm.

On the other hand, Consumer Discretionary has less foreign exposure and a greater tilt toward the Pacific.  China’s recent economic reacceleration is therefore a plus.  But there’s less chance of currency gain.

no?

If portfolio managers begin to reallocate money to Staples, where will the funds come from?  It’s not clear to me that it will come from Consumer Discretionary.  It might well come from Energy, Materials, Technology or Industrials–all more cyclical industries than Consumer Discretionary.  If so, both Discretionary and Staples might do well.  In fact, although I haven’t thought this through enough, my hunch is that this is what will happen.

To me, the relevant points are that Staples are statistically cheap and that there’s a reason to think better times are in store, at least for US-based firms.  Whether this potential outperformance comes at the expense of Discretionary is much less important.

 

reversion to the mean

October 30, 2013 By in book value, distressed assets, from growth to value: the life cycle, growth vs value, mean reversion, two flavors of value Tags: , , , , , , , Leave a comment

Mean version has two senses:

1.  The first is important for traders, less so for investors.  It’s that if we construct a trend line or moving average for a stock from past prices, the stock will tend to trade in a reasonably well-defined band or channel around the trend.  In theory at least, one can make money by buying when the stock is at the lower edge of the band and selling when it’s at the higher edge.

2.  The second is a cardinal tenet for value investors.  It’s that over long periods of time stocks in general tend to rise and fall in line with overall earnings performance, which is, in turn, a function of the ebb and flow of nominal GDP.  Some stocks may have episodes where they perform far better than that.  Others may have extended periods when they fall far short of this mark, which in the US probably averages around +8% per year.  The value investor’s argument is that both classes, serial outperformers and serial underperformers alike, will inevitably see their fortunes reverse and their stocks revert to the long-term mean performance.

For high-fliers, this means they’ll, sooner or later, crash and burn.  For the stock market’s junk pile, on the other hand, its denizens will have periods when they’ll rise like the phoenix.  The latter are what value investors look for.

old school value investing

For some value investors, this is it.  This is all they do.  They run screens that find the cheapest stocks based on price/cash flow, price/earnings or price/assets–or some combination of the three.  And then they buy them.

I knew one who systematically went through books of charts looking for stocks that had experienced catastrophic drops (not a good strategy–once they figured out what he was doing, brokers began to send this guy charts with the price axis stretched out and the time axis compressed, so that every stock they touted looked like a train wreck.  Last I heard–I was hired to clean up the unholy mess he created–he was selling real estate in the Philippines).

Every investor is in some sense a contrarian.  At the very least, we all believe that the stock we are buying has more up left in it than the seller does, and the stock we are selling has less.  We also know the cardinal rule is to “buy low and sell high.”  Nevertheless, I think the simple strategy I just outlined, which is at the heart of the value investing practiced a generation ago, no longer works.

Why am I writing about this today?  

I was listening to Bloomberg radio in my car yesterday,when Dave Wilson repeated the observation of a market strategist that the divergence between the strong relative performance of the sector ETF for Consumer Discretionary and the weak outcome for Staples was as great as it was just before the Internet bubble popped in 2000.  What followed was a fierce reversion to the mean by both sectors.

The implication was that this factoid is significant.  As usual for Bloomberg, what or why was not forthcoming.

More tomorrow.