I don't know whether we'll finish 2000 with a classic year-end rally. Every painful drop that takes the
Nasdaq Composite Index
closer to May's low of 3165 makes a rally more likely, I believe, but with worries about the fourth quarter hanging over this stock market, it's by no means guaranteed that the bull will pay even a short visit in November/December.
But I do know what three hurdles stocks have to jump before that's even a possibility.
They've just about cleared the first -- earnings-warning season -- with bad bumps from
, to name just a few.
And the market is now lining up to begin its run at the second set of obstacles -- sell-on-earnings-reports season -- starting next week. Companies that report good third-quarter earnings during the next few weeks could see their stocks plunge if investors decide that prospects for the fourth quarter are potentially disappointing. Stocks will be busy jumping these first two challenges for most of October.
Before equities are done with that task, though, they'll be getting ready to face the third and final set of hurdles. As the fiscal year draws to a close for institutional investors such as mutual funds, professional money managers will be selling their losers to offset profits and capital gains taxes on any winners that they've sold this year. October tax-loss selling will put yet more downward pressure on stocks -- as if stocks needed more problems right now.
This last wave of selling pressure won't wash over every stock evenly, of course. Some shares are likely to escape completely. Others may sink just a little with the general ebb of the tide. Still others are likely to face a relentless river of selling; the current on these will flow strongly and relentlessly downward -- for a month anyway.
I don't think it's possible to come up with a magic formula that will tell us precisely which stocks belong in each of these three categories. Investors decide to sell stocks to generate tax losses after looking at a complex set of conditions that include when they bought the stock, how steeply it has fallen recently and projections of how well it will perform going forward. And investors make these decisions not just with an eye on their own portfolio and tax returns, but with constant adjustments based on what everyone else seems to be doing.
What a Near-Term Loser Looks Like
All that means is that investors trying to decide what stocks will go down during tax-loss selling season are faced with the same uncertainty they confront in a rising market when trying to pick stocks that will go up. In a climbing market there's no way to put together a list of stocks that are guaranteed to climb, but we can and do isolate factors that have, historically, increased the probability that a stock will go up. In the same way, during tax-loss-selling season, we can put together a list of traits that, in combination, are good indicators that a stock will face downward selling pressure during this period. Investors who want to limit their potential losses during this period should avoid stocks that closely fit this profile. Investors looking for bargains to buy for any potential year-end rally should wait to buy battered stocks that fit this profile until late October or early November, when most institutional tax-loss selling will be completed.
Here's my profile of a stock that will face selling pressure from tax-conscious investors.
- Institutional investors make up a majority of owners. If institutions don't own it, they can't sell it. Pretty simple. (Individual investors certainly sell for tax purposes, but it tends to be later in the year, after the institutions have finished in October.) Big-company stocks generally have majority institutional ownership. Institutional investors own 51% of
Dell Computer (DELL) - Get Report, for example, 65% of
EMC (EMC) and 62% of
Chase Manhattan (CMB) . But even in this group the range can be extreme.
Wal-Mart Stores (WMT) - Get Report is only 34% owned by institutions, and
AT&T (T) - Get Report, 37%. By and large, the range spreads out as
market capitalization decreases. In the $4 billion to $10 billion segment of the market, for example, institutional investors own 85% of
Avon Products (AVP) - Get Report and 70% of
The Limited (LTD) , but only 12% of
Akamai Technologies (AKAM) - Get Report and 17% of
Knight Trading Group (NITE) .
The stock is showing a major loss from its "popular" high for the year. Can't sell it to generate a loss if the stock hasn't tanked. That's pretty obvious. But what do I mean by "popular" high? That's a high with lots of volume that lasted for a good while. Lots of investors had a chance to buy at this price -- because of its duration -- and the high volume during the period shows that they did. For example, contrast
Wind River Systems (WIND) with Intel. Wind River traded above $50 for about a month in the spring, from Feb. 28 through March 28, and the chart shows only one brief volume spike during that period that pushed trading substantially above 2 million shares in a day. Intel, on the other hand, traded above $60 a share from March 15 through Sept. 21, except for three brief spikes down to $55. Even in the summer doldrums, volume was often above 40 million shares a day. Wind River closed at $44.13 on Oct. 3; from the chart, I'd say relatively few investors have a major tax loss in the stock. That same day, Intel closed at $40.31. Millions of investors -- and 54% of the stock is in institutional hands -- are likely looking at losses of $20 a share or more on Intel.
The stock or its group is out of favor going forward. No investor willingly sells to generate a tax loss knowing that he or she will have to scramble to buy the stock back before it starts a major run. The ideal candidate for tax-loss selling is instead a stock that faces tough sledding in the year-end period, at least as far as the current consensus goes. An individual stock such as AT&T fits that definition to a T right now. The stock was above $45 a share for the first four months of the year before falling to a recent $30. But just as important, according to the consensus, there's no quick turnaround in sight for this stock. Management and strategy are fundamentally flawed. That makes AT&T a safe tax-loss sell. It isn't going to double in a month and embarrass the seller. Whole groups of technology stocks fit this description right now. According to the consensus, sales growth is slowing for PC makers, and the fourth quarter could bring further bad news. And slowing PC sales mean slowing orders for semiconductor equipment makers. That thinking may be wrong -- I think it is when it's applied to equipment makers -- but it is the current consensus, and it makes it likely that Intel, Dell and
Applied Materials (AMAT) - Get Report could all see tax-loss selling in October.
The stock has broken through major technical support in the recent market rout. Let's see ... On one hand, you could hold such a stock and hope that it doesn't fall another 20% to the next level of support. Or you can sell, generating a tax loss and putting in some downside protection. That's a tough one. I'm sure that some institutional investors who bought
IBM (IBM) - Get Report above $120 a share between Aug. 10 and Sept. 26 are weighing this one very carefully right now. The stock broke through its 200-day moving average at $114 on Sept. 29 and then moved down to close at $110 on Oct. 3. The next support on this stock below $110 is at $90.
The stock isn't a must-own name. If you run a technology portfolio, you have to own
Cisco Systems (CSCO) - Get Report. In the retail sector, you need Wal-Mart and
Home Depot (HD) - Get Report. But it's easy to imagine a technology portfolio without
Citrix Systems (CTXS) - Get Report or
RealNetworks (RNWK) - Get Report, and a retail portfolio without
J.C.Penney (JCP) - Get Report or
Saks (SKS) .
All the sellers haven't been washed out of the stock. When a stock takes a really big hit -- I mean really big -- and then struggles in the mire for months, the investors who are left are true believers. If you held
Excite@Home (ATHM) - Get Report, for example, from $86 to $20 and then still held on when it dropped to $12 recently, I'd say that it would take more than a tax loss to make you sell now.
Here's my list of 10 stocks that I think fit these six factors: Intel,
, Applied Materials, Apple Computer, Xerox,
. I'm sure that in the current market, you'll have no trouble adding names of your own.
These are all cheap stocks, but I think they could stay cheap and maybe even get cheaper as October rolls along. I think the market will be wrong on some of them as we get into November, but I think the selling pressure isn't about to go away in a day or a week. They are stocks to buy later -- and not sooner -- in October.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Applied Materials, Ariba, Broadvision, Cisco Systems, EMC, Home Depot, Global Crossing, GlobeSpan, Intel, Nokia, RF Micro Devices and Wind River Systems. He welcomes your feedback at
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