The post-election sell-off in the market has acutely reminded
everyone of the impending Fiscal that Cliff the US faces in less
than 2 short months.
This is when tax rates are scheduled to go up while spending cuts
are slated to kick in.
It's a one-two punch that could have a devastating effect on the US
economy and world markets. And it's why other world bodies, such as
the G-20 and the IMF, are urging the US to resolve the issue as
soon as possible, given how fragile the global economy is at the
The good news is that many believe some sort of compromise will be
made. Many of the tax cuts for the overwhelming majority of
Americans are likely to stay, while the massive, across the board
spending cuts will likely be redefined as more thoughtful cuts,
spread out over a longer period of time.
But, a compromise only serves to make the Fiscal Cliff smaller. It
does not erase it. So there will be some short-term pain. But if
it's done in a way that can reduce the deficit while at the same
time not derailing growth in any meaningful way (or better yet,
promote it) the markets should be fine.
So Why is the Market Coming Under Such Pressure?
I believe it's because tax rates on investments appear likely to go
The tax rates on long-term capital gains, which now stands at 15%,
is likely to go up to 20% (21.2% if you add in the new taxes that
will be levied due to the Affordable Healthcare Act) and possibly
as high as 25% (when an additional 3.8% tax, also part of the new
health care law, goes into effect for the highest income earners).
Short-term capital gains, as well as taxes on dividends, might go
up as well.
That's why there is an incentive to lock in gains now before rates
For example, if someone amassed $100,000 in long-term capital
gains, he would have to pay $15,000 in taxes. However, if he
waited, and hoped for the best, he could then, conceivably, have to
pay $25,000 on that same $100,000.
Now let's say you have tens of tens of millions of dollars of
gains, or more. You could sell now and pay only 15% on those gains,
or wait and sell later, and potentially pay 66% more in taxes.
Nobody knows for sure if this will happen. But, this is why many
top advisors are telling their wealthiest customers to lock in
their gains now to take advantage of what could be the lowest
capital gains tax rates they'll see for the rest of their life.
I believe this is all short-term in nature however. Because if a
deal is made on the Fiscal Cliff, higher investment taxes
notwithstanding, the economy will stay the course and the market
should ultimately go back up, which means all of that money should
find its way back into the market, as the US will still be
considered the best game in town.
But for now, I believe the market will come under pressure
throughout the rest of the year as investors race to benefit from
the low tax rates that might soon expire and go up.
Stock Picking Strategy to Beat the Tax Induced
So where will some of that money go (it's unlikely to just sit in
'cash') and where should new investment dollars go while this tax
strategy induced selling runs its course?
I laid out one strategy in a post-election webinar we did last
week. And I've been asked to flesh this out a bit more. So here it
I believe the stocks with the largest gains over the last 1-3 years
are prime candidates to see the greatest amount of tax related
On the flip-side, the ones with smaller gains to lock in should see
the least amount of tax induced selling.
Of course, that doesn't mean you should buy the crummiest stocks
out there. You still want to make sure the odds are in your favor
for future gains.
My strategy right now is as follows:
Focus in on the Top 50% of Industries
Specifically, focus in on the top 50% of Zacks Ranked Industries.
For one, the top 50% of industries has been show to beat the
bottom 50% of industries by a factor of more than 2 to 1. This
one item alone helps put the odds in your favor of getting into a
Select Stocks with a Favorable Zacks Rank
This screen selects Zacks #1 Rank and Zacks #2 Rank stocks, which
are Strong Buys and Buys, respectively. You can choose to include
some Zacks #3 Rank stocks or Holds if you'd like. But with the
Zacks #1 Rank stocks showing over a 25% average annual return of
over the last 26 years and the #2's doing over 18%, this is item
that can further tilt the stock picking odds in your favor. And
by focusing in on the best Zacks Ranked stocks, you can be sure
those are the ones receiving the best upward earnings estimate
Pick Stocks that have Underperformed the Market This
The item I'm using to determine underperformance is the Relative
% Price Change vs. the S&P 500 over the last 52 Weeks. But
I'm also making sure that they were up for the year so there's no
incentive for tax loss selling either. For that, I'm using the
simple % Price Change over the last 52 Weeks. As mentioned
earlier, stocks that outperformed and have racked up big gains
are likely to come under the most tax related selling pressure.
Those with smaller gains should suffer the least amount of
selling pressure, since there's a smaller tax advantage to
This strategy will produce approximately 50 stocks at a time.
Once you generate this list, be sure to apply your favorite, proven
valuation metrics to further narrow down your selection to find
those with the best value.
After the first of the year, and as soon as we get a bit of clarity
of what the Fiscal Cliff will look like, my focus will then be on
those stocks that were the best outperformers over the last 1-3
years, but that suffered the biggest declines over the last few
months. As long as those stocks still have their fundamental and
technical stories intact, those will likely be the stocks that will
see the most amount of investor interest as they'll be able to pick
up their favorite stocks at a meaningful discount.
But that's for another time and another article.
For now, take a look at the underperformers, but with the best
short-term outlooks, as a place to stash your money until the
strategy of tax selling is over.
5 Stocks to Beat the Tax Selling Trap
Here are 5 highlighted stocks from this week's screen:
- They are in the Finance - Investment Management Industry. They
are ranked 42 out of 265 industries, placing it in the top 16% of
Zacks Ranked Industries. They have a Zacks #2 Rank (Buy). There's
little incentive to sell for tax purposes considering their 1.04%
gain over the last 52 weeks. But this company's services should be
highly sought as the tax landscape changes for both investments and
Camden Property Trust
- This Residential REIT has a Zacks #2 Rank (Buy), while its
industry is ranked 52 out of 265 for a spot in the top 20% of Zacks
Ranked Industries. With only a 7.8% gain over the last 52 weeks,
it's unlikely to experience much end-of-year tax selling. But with
the entire housing market expected to continue its recovery in
2013, CPT should benefit nicely going forward.
- This stock is also in the Finance industry, but categorized under
Misc. Services. They are ranked 32 out of 265, putting it in the
top 12% of Zacks Ranked Industries. They're up 8.4% over the last
52 weeks, but have been confined to a relatively narrow trading
band for the last 3 years. However, they currently sport a Zacks #1
Rank (Strong Buy) in an industry that keeps growing (they provide
secure electronic transaction solutions). An upside breakout could
be just around the corner.
- They are one of the most widely known and trusted food products
companies in the world. They have a Zacks #2 Rank (Buy) in an
industry ranked in the top 10% of Zacks Ranked Industries (25 out
of 265). They had a solid year in 2010, but have pretty much traded
sideways for the last two years and have essentially been flat for
the last 52 weeks with a 0.07% gain. There's little reason to sell
for tax reasons if you got in over the last couple of years. But
with a big base building near its 52-week high, this one looks set
to breakout to new highs, as stocks trading near their highs have a
tendency of doing.
- They are in the Staffing Industry within the larger Business
Services Sector. They are ranked in the top 41% of Zacks Ranked
Industries (108 out of 265), making the cut for the top 50% of
industries with room to spare. Employment has been a drag on the
economy. This is likely why RECN has only been able to show a 3.14%
gain over the last 52 weeks. But the jobs market is slowly getting
better. And with RECN's Zacks #2 Rank (Buy), and solid double-digit
projected growth rates, so should their fortunes.
Get the rest of the stocks on this list, and start fortifying your
portfolio as the end of the year tax selling pressure picks up
steam, and the theatrics surrounding the Fiscal Cliff fight heats
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Disclosure: Officers, directors and/or employees of Zacks
Investment Research may own or have sold short securities and/or
hold long and/or short positions in options that are mentioned in
this material. An affiliated investment advisory firm may own or
have sold short securities and/or hold long and/or short positions
in options that are mentioned in this material.
Disclosure: Performance information for Zacks' portfolios and
strategies are available at:
BLACKSTONE GRP (BX): Free Stock Analysis Report
CAMDEN PPTY TR (CPT): Free Stock Analysis
EURONET WORLDWD (EEFT): Free Stock Analysis
HORMEL FOODS CP (HRL): Free Stock Analysis
RESOURCES CNCTN (RECN): Free Stock Analysis
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