a stealth selloff?

Typically the US stock market sells off in September/October. What motivates the decline is preparation for the end of the mutual fund tax year on Halloween, and the distribution of realized gains that follows. In the earliest days of my investing career–that is to say, in the late 1970s-early 1980s–the seasonal selloff came in November/December instead, because the biggest market players back then were banks and insurance companies, whose fiscal year ends on New Year’s Eve.

As I’m writing this, we’re three weeks into September and the S&P 500 is roughly flat so far this month. Typically, fund accountants ask managers not to transact a lot during the last two weeks of the fiscal year, to minimize the (miniscule, in my experience) chance of an unsettled trade carrying over past yearend. So we’re running out of time for a significant period of portfolio overhaul. What’s going on?

Three thoughts:

–there’s still time for something to trigger selling–like the rising oil price–so it’s too early to conclude that no seasonal selloff will occur this year. It is time for some head scratching, though

–large flows tend to come into mutual funds/ETFs at the top and to go out at the bottom. So it’s thinkable that stock mutual funds in general already have large tax losses from redemptions late last year and early this. Remember, too, most Wall Street strategists were calling for a substantial market decline in early 2023, creating an atmosphere encouraging customers to sell (at much lower prices than today’s). So maybe funds already have a bunch of realized tax losses. If so, that part of annual tax planning is already done. What remains is to offset those losses by trimming winners

–there’s some evidence that this last is happening. NVDA, for example, is off by about 10% this month, MSFT and AAPL by around 5% each. ARKK, which is still up by 30%+ in 2023, has declined by about 7% this month (not a comment about the ETF’s flows, rather the recent performance of holdings that have been up a lot so far in 2023).

I’d been thinking that if the typical seasonal selloff were to happen, that would be a great chance to pick up stock being sold purely for tax reasons, not for any weakness in company business. Maybe there’s still a chance, but time doesn’t seem to be on my side.

the house down the road…

…has been unoccupied since the financial crisis of 2007. As I understand it, someone bought it during the heady housing-boom days of 2006, when it would have been worth about $150,000, but in short order mailed the keys back to the bank that held the mortgage and left town.

There were a couple of early, unsuccessful attempts at sheriff sales to recover unpaid property taxes. But the property has lain dormant since, until the mortgage owner held an online auction a month or so ago.

The most interesting part of this to me is that there had been a lien against the house of around $600,000, or almost 4x the eventual selling price.

I presume this loan was part of a larger package sold to institutions, the nuts and bolts of which I have no idea about. I think the rationale for keeping it on the books for such a crazy amount must have been:

–the 2006 mortgage could have been for, say, $300,000. If so, the major purpose for seeking the original loan was to take the money and run, but the mortgage-holding entity never detected this and relied on the original appraisal

–the entity that held the loan continued to accrue unpaid interest and penalties, showing this in the accounting statements either as income or an addition to reserves, even though no money was coming in. …making a big minus into an apparent plus

–there was no mechanism in the package for regular portfolio pruning–seizing a non-performing property, paying accrued taxes and selling it

Please comment if you have any ideas.

Two conclusions:

–I think we’re in the early days of a cyclical shipwreck of unusually large size in the office building market in the US. My guess is that we’ll be seeing a similar period of loan holder reluctance to write either office building asset value or the loans they secure down to fair market value

–my guess is that this mortgage is part of a large package that has come to the end of its life and is being liquidated. It would be a lot worse if banks were clearing the decks of housing exposure to accommodate a large inflow of dud office building loans.

the heavy half and portfolio management

Consumer products marketers often talk about the “heavy half.” The idea is that a relatively small subset of a product’s buyers use the product often enough that they generate most of the sales. Say, 10% of the Bud Lite users account for 60% of the cases sold. The Pareto Principle, the idea that 20% of the customers create 80% of the sales, is another way of framing the same idea.

There’s something like the heavy half in equity portfolio management, especially for growth-style managers, who typically hold much more concentrated portfolios–maybe 50 stocks, maybe fewer–than their value counterparts, who can have a couple of hundred names. In all likelihood, three or four of the stocks in a growth portfolio will end up creating most of its outperformance.

The other 45+ are there for two related reasons:

–no one knows, or at least I don’t, when an idea will catch fire in the overall market. If I’m lucky I have a pool of ten solid ideas that I think could do very well. Experience tells me that only two or three names will perform in the way I’m expecting, but I really don’t know which ones they’ll be. So I hedge.

–the rest of the portfolio is there for defense, to force me to be aware of what’s happening in sectors I see less potential in and to mitigate the damage if the areas I’ve taken money from to build up my overweights begin to perform better than I think they should. Yes, I expect to make money in these areas, but it’s more important to me that they not punch a huge hole in the bottom of my boat.

Not everyone follows this approach. Take the ARKK portfolio of billionaire Cathie Wood. Its results over the past five years are as follows:

Tesla +1300%


S&P 500 +55%

ARKK -7%.

Ms. Wood understood far earlier than the consensus (me included) the profound changes in the automotive industry that TSLA would set in motion. If she had become a sell-side auto analyst, she might well be the most famous securities analyst on the planet.

If we assume that she maintained an average 5% position in TSLA in her ARKK fund over the past five years (I’ve plucked a figure out of the air that seems right to me, but I make no claim that this is correct; the TSLA position is 11.8% now). If so, TSLA would have contributed about +65% to overall portfolio performance. This would imply that the non-TSLA portion of the portfolio lost something like 60% of its value over the last-half decade (even after adjusting for distributions amounting to about 10% of nav over the period). This is in a NASDAQ market that was up by 73%.

If the average TSLA position were 2%, its contribution to overall results would be +26% and the rest of the portfolio would have lost about a quarter of its value.

I’ve been sitting here for a while, thinking to myself that, given the apparent magnitude of the underperformance, the last four paragraphs can’t possibly be correct. I got the performance figures from Yahoo Finance, however, and the distribution amounts from the ARK website. I did add the 10% to ARKK performance rather than doing a time-weighted calculation, but that shouldn’t have made much difference–and the NASDAQ and S&P results remain capital changes, not total returns, giving ARKK an edge.

I guess it’s possible Ms. Wood traded TSLA badly or that she abandoned what I think has been her best idea for part of the time. Still, this is an example, more extreme than I’d realized, that defense counts for a lot.

the ARM IPO next week

TSMC and ARM are the two most important chip companies from late last century (or 20-some-odd years ago, if we want less drama). TSMC allowed talented chip designers to break away from the lumbering integrated giants of the day–INTC or TXN, for instance–by offering them access to state-of-the-art manufacturing facilities. So they didn’t have to come up with billions of dollars to build their own fabs. ARM offered them standardized software tools for rent, so designers could concentrate on innovation rather than spend a ton of time creating their own hammers and saws.

Softbank, a Japanese investment company controlled by Masayoshi Son, which after a brilliant start has had a tough 21-century so far, owns ARM. It attempted to sell ARM to NVDA for $40 billion in 2020, but was shot down by anti-trust concerns. So it has decided on an IPO instead, with ARM making its stock market debut on September 13th.

I haven’t read the preliminary prospectus, which is available on the SEC’s Edgar site (ARM is going to be the ticker symbol). The offering price, just under a tenth of the company being sold, is being set as $47-$51 per share. This would value ARM as a whole at around $50 billion.

What I find interesting, and the reason I’m writing this, is that I’ve already gotten a blast email from Fidelity offering the possibility of getting an allocation of shares.

I don’t read this as a sign that demand is red-hot. It’s hard to know if the issue is the company/price or whether the apparent hodge-podge of US, UK and Japanese bankers is closer to the Mets/Yankees than the Braves/Orioles.

entering September

April may be the cruelest month, but for investors September (really, the four or five weeks from mid-September to mid-October) is by a considerable margin the worst month for US stock performance.

The reason is pretty simple. Mutual funds are required by law to distribute basically all their realized capital gains and net dividend income to shareholders. That’s because fund holders have to pay income tax on these distributions and Washington wants to collect income tax as fast as possible. So the government pushes funds to end the fiscal year on Halloween, something that every one I’m aware of does. That gives a fund time to close the books and still pay shareholders before the current tax year ends.

Oddly, to my mind anyway, fund holders like to get distributions and regard them as a mark of fund success. So the approach of the fiscal year end has become the industry’s trigger for managers to realize capital gains. And that turns into the occasion for making a general tune-up of the portfolio. Funds trim outsized winners to create funds for distribution to shareholders. And they also tend to use this tax-selling time to toss clunkers overboard and realize capital losses. In both cases, they sell.

This selling usually begins around the second week in September and dries up in the middle of October, giving trades ample time to settle before the fiscal year end.

Last year during this period, selling was unusually severe, with NASDAQ losing about 15% and the S&P 500 a bit less. This decline also came after a ~5% fall from mid-August highs. But the end of selling also marked an important market bottom.

My hunch is that this year’s experience will be relatively tame, both in comparison with 2022 and in absolute terms. I’m not willing to bet the farm on this thought, but I’m also content not to do any selling based on worries about a repeat of the 2022 losses in 2023.

My biggest concern is that trading bots will mindlessly try to replicate last year’s trading. It will be interesting to see if they do, and, if so, how successful they are.

Two thoughts for you and me:

–there’s nothing to prevent us from doing a portfolio overhaul of our own, something we should all do regularly, and

–if bots run wild, we may have a great chance to buy in a few weeks.