mutual fund tax selling
According to the internet, about 20% of the capitalization of the US equity market is held in mutual funds. Another 15% of the US market cap is held in ETFs. The mutual fund number is about the same percentage as in 2000, when ETFs didn’t exist.
ETFs are by and large taxed to holders as if they were individual stocks. That is, the tax effect is on capital gains/losses from you and me selling. I really don’t know what happens in the case of an ETF complex like ARK, which as of the semi-annual report in January still had several billion dollars in unrealized losses on its balance sheet. My guess is that no one writing the rules anticipated that this could happen.
The mutual fund case is much clearer. Fund transactions aren’t taxable to the fund. But funds are required to distribute all realized gains to shareholders, who must pay income tax on them, at the end of the fiscal year–usually October. For some reason, holders actually like to get distributions, even though most automatically reinvest the distributions in the fund.
Fund managers typically spend a considerable amount of time tax planning in the six weeks or so between early September and mid-October. They sell stocks they have gains on to offset losses from things that haven’t worked out, and they sell to recognize gains for distribution to shareholders.
Last year, for example, the S&P fell by about 4% in the first couple of weeks of September before rebounding. In the overall scheme of things, not a big deal. Arguably, a chance to buy.
Also, in many years, the absence of selling pressure post-Halloween starts the “Santa Claus” rally, which typically continues through early December–when professionals tend to break for the holidays.
trumponomics
What stands out to me is that the dollar has stopped falling and the S&P, while still a world laggard at +9.6% ytd, has gained about 30% from its April lows (“laggard” is due to the 10%+ drop in the dollar since the inauguration). NASDAQ, although “only” up by 11.7% ytd, is 47% ahead of its April lows, as well. Gold, a traditional safe haven in bad times, is ahead by 30% ytd, but flat since early May.
Why the market strength?
Let’s take out the crayons and work in the simplest possible terms. Say that the typical US multinational has 50% of its revenues outside the US, that it has all its costs in USD (think: big tech) and that it has an operating margin of 30%. The dollar falls by 10%. This means total revenue in USD rises by 5%. Costs are unchanged, so the overall operating margin expands, like magic, to 35%. That’s a 16.7% gain in operating income, over what one might have projected at the beginning of the year.
On the other hand, if I have dollar revenues and non-dollar costs, I’m crushed.
This pattern reminds me of Japan in the 1980s, only in reverse. In that case, a strengthening yen crushed export earnings but increased the world value of importers and purely domestic firms a lot. In the current US case, the domestic economy gets hammered, but exporters do very well.
If we push the Japan analogy, though, the long-term results aren’t so rosy. The boom there in the 1980s was followed by decades of stagnation. What triggered the reversal? …as I see it, a series of policy decisions that resulted in the working population declining. Three aspects: overall population aging, failure to accept women in the workforce, and not permitting immigration.