Tax-Loss Harvesting: A Potential Booster for S&P 500 Underperformers

Tax laws in 2023 may have a beneficial impact on some of the S&P 500’s laggards, but there may be a storm before the calm. The key lies in tax-loss harvesting, a technique used by investors to sell their underperforming stocks and bonds in order to offset taxable capital gains elsewhere. While the deadline for most mutual funds to sell is Oct. 31, retail investors have until Dec. 31 to take advantage of this strategy.

According to Jessica Rabe, co-founder of DataTrek Research, mutual funds engaging in tax-loss harvesting are expected to exert selling pressure on the underperformers within the S&P 500 over the next week. In a recent note, Rabe highlighted a list compiled by DataTrek of the top 10 worst performers in the S&P 500 this year that could potentially become tax-loss candidates. The research suggests that these stocks could witness a rebound starting in November once mutual funds conclude their tax-loss selling.

The list of potential candidates includes SolarEdge Technologies (SEDG), Enphase Energy (ENPH), Moderna (MRNA), FMC (FMC), Dollar General (DG), AESCorp. (AES), Insulet (PODD), Etsy (ETSY), Estée Lauder (EL), and KeyCorp (KEY). Notably, four of these stocks—Enphase, Moderna, FMC, and Estée Lauder—reached new 52-week lows this week.

Rabe explains that the strategy behind tax-loss harvesting is to identify equities among the worst performers that exhibit attractive fundamentals or valuations. Investors then patiently wait for the weeks following the Oct. 31 deadline when tax-loss selling subsides.

In summary, the potential bounce-back for S&P 500 underperformers lies in tax-loss harvesting. Investors can capitalize on this strategy by carefully selecting stocks and bonds that may rebound after the pressure from mutual fund tax-loss selling dissipates.

Mutual Fund Tax-Loss Selling: A Test of Investor Confidence

Mutual fund tax-loss selling has the potential to further drive down already struggling stocks. However, keeping a close watch on these stocks until the end of the month, as well as in the weeks after, could yield a bounce through year-end. This is according to a note by Rabe, a prominent analyst.

A Litmus Test for Investor Confidence

Rabe emphasizes that these stocks will serve as a litmus test for investor confidence over the next two months. While there may be another round of selling near year-end due to individuals engaging in their own tax-loss selling, the interim period should see modest improvements in these stocks if the markets are inclined to bottom fish.

Patience is Key

The analyst cautions that it may take a few weeks before tax-loss-sale stocks begin to rise. However, she firmly believes that this strategy aligns with her firm’s “strong January playbook.” This playbook is based on a historical analysis of market behavior following outsized gains in the S&P 500, such as those observed in 2023.

Rallying Towards the Year-End

Rabe highlights that U.S. equities have consistently traded close to the January indicator months after experiencing notable gains early in the year. Additionally, she points out that in years past, the S&P has performed significantly better in November and December compared to October. This observation is consistent with the well-known “Santa Claus rally.”

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