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MARK E TS

The stock market rotation that rocked

investors this month may have been
driven by a technicality
PUBL I S H ED SAT, SE P 21 2019 • 8:4 5 A M EDT | UPDAT E D SAT, SEP 21 2019 • 11: 5 8 A M EDT

Yun Li
@YUNLI626
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KEY The reversal in momentum, which seemed to abate this week, could be explained by
POINTS a sudden stop in tax loss harvesting, some on Wall Street said.

Investors often sell losing stocks to lower their capital gains tax bill.

Tax loss selling might have stopped due to speculations the Trump administration
would pass a bill to reduce capital-gain taxes, according to Barclay’s head of equity
derivatives strategy Maneesh Deshpande.

A trader works at the New York Stock Exchange in New York.

Wang Ying | Xinhua News Agency | Getty Images

What exactly happened during the “once in a decade” stock market rotation
earlier this month that rocked investors? It might’ve just been a one-off
technical move and not based on fundamentals.

A huge rotation out of momentum into value names took place suddenly last
week. Many read the phenomenon as a warning sign as stocks with superior
growth have led the market’s bull run in recent years and said a rebound in
interest rates was the catalyst. However, the reversal in momentum, which
seemed to abate this week, could be explained by a sudden stop in tax loss
harvesting, some on Wall Street said.

The idea is that investors often sell losing stocks to lower their tax bill from the
capital increases, a technical move that’s quintessential of a momentum trade
— chasing winners and dumping losers. The amount of such activity might
have decreased significantly last week due to speculations the Trump
administration would pass a bill to reduce capital-gain taxes, therefore
reducing the incentive to sell their losers.

“It’s quite possible some of the dominant robo advisors could have assumed
that the U.S. administration would indeed follow through with its proposal on
Sept. 9, and decided to change their optimization to take this into account,”
Barclay’s head of equity derivatives strategy Maneesh Deshpande said in a note
on Wednesday.

President Donald Trump earlier this month floated a proposal to tie capital
gains taxes to the inflation rate, which could lower the taxes investors pay on
profits from selling assets. He eventually ruled out such a plan on Sept. 11. But
the discussion around the proposal last week coincided with the change in
stock leadership that shocked many investors.

Tax loss harvesters might have stopped selling losers and adding winners on
the prospect that capital-gains taxes would go down, which could make tax loss
selling less beneficial. Such a change could have caused the downturn in
momentum due to less selling of falling stocks and less buying of rising names.

The amount of active tax loss harvesting has ballooned over the years as robo-
advisers, which automatically allocate assets in a tax efficient way, gained
popularity on Main Street. Robo-advisers now manage about $1 trillion assets,
up from $240 billion in 2007, according to Barclays.

“Of course, it is also entirely possible that some other investors would have put
on the trade in anticipation of such a proposal,” Deshpande said.

The iShares S&P 500 Value ETF hit its highest level since January 2018 on
Sept. 11 as the rotation hit its pinnacle.

Value, cyclical companies with low prices relative to earnings and book values
tend to be sensitive to economic growth. However, embracing the group
without a material change in the economy doesn’t make a lot of sense, analysts
warned.

“Absent an improvement in underlying economics, we believe that the recent

shift in leadership is unlikely to persist,” Jonathan Golub, chief U.S. equity
strategist at Credit Suisse said in a note Monday.

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