The period from November through January historically has been the best three-month stretch for stocks since 1936, according to analysis by Bank of America Merrill Lynch cited in a recent report by Business Insider. Tax-motivated selling by mutual funds and other investors drive this seasonal pattern.
Meanwhile, strategists at BofAML have identified 16 stocks with solid fundamentals. that should rebound after tax-motivated selling. Here are 7 of them: CBS Corp. (CBS), Viacom Inc. (VIAB), Centene Corp. (CNC), DuPont de Nemours Inc. (DD), F5 Networks Inc. (FFIV), Kroger Co. (KR), and DXC Technology Co. (DXC).
- The best 3-month period for stock gains is November-January.
- This is based on history from 1936 onwards.
- Tax loss selling by mutual funds and other investors create bargains.
Significance for Investors
Based on data since 1936, BofAML finds that the S&P 500 Index posts an average total return, dividends included, of 4.4% in the three month period from November through January. The average total return for any other three-month period is 2.9%. BofAML looked at 12 different periods, each with a different set of three consecutive months.
BofAML attributes their finding to the fact that mutual funds must sell a stock by Oct. 31 to recognize a capital loss for tax purposes during the same calendar year. After that deadline passes, such stocks often recover.
Additionally, other investors engage in tax loss selling, or tax loss harvesting, late in the year. This depresses the prices of losing stocks yet more, often creating bargains that rebound in January.
Media companies CBS and Viacom are slated to merge, and both are valued cheaply, with forward P/E ratios less than 7x projected next 12 month earnings. Both also are down by more than 12% year-to-date. Their cheap valuations and sinking stock prices suggest low expectations about future growth, with the combined company lagging in the increasingly competitive video streaming market, according to Barron's.
Grocery chain Kroger has been losing market share to Walmart Inc. (WMT), but the stock bounced by 11.4% on Nov. 5 based on profit guidance for its fiscal year 2020 that exceeds consensus estimates. After retreating by 3% on Nov. 6, its share price is virtually unchanged in 2019, with a forward P/E under 12x.
For fiscal 2020, Kroger projects same store sales, excluding fuel, to grow by 2.25%, free cash flow (FCF) of $1.6 billion to $1.8 billion, outlays of $500 million to $1 billion on share repurchases, and significant growth in "alternative profit businesses," per Zacks Equity Research. Beyond fiscal 2020, the company forecasts annual earnings growth of 3% to 5% and strong FCF that generate annual total returns to shareholders between 8% and 11%. The "Restock Kroger" program is designed to produce operational efficiencies while also giving consumers greater choice and better service at lower prices.
A previous report presented 10 other stocks that may benefit from tax loss selling, plus year-end window dressing by fund managers. Veteran market watcher Mark Hulbert, using data from 1926 onwards, found that a hypothetical portfolio of the worst-performing 10% of stocks during the prior 12 months, rebalanced monthly, delivered, on average, monthly losses in Q4, but significant monthly gains in Q1.
While history indicates that tax loss selling can create bargains, past performance does not guarantee future results. Also, Hulbert warns that "it’s important to be choosy and not indiscriminately buy just any stock that has performed dismally." Like BofAML, he also applies additional analysis to select beaten-down stocks with attractive fundamentals.