Equities
Richard Coppleson

With investors making big profits this year in certain stocks, there will be many investors who will want to offset these profits via selling their losers to lock in their tax losses and thus reduce their tax bill. I have been watching the tax loss phenomenon in the market closely for the last 30 years, and time after time it’s the same script.

The ASX 200 is normally down in early June (and then bounces hard in last few weeks in June). 

This year it could easily be on, given that we have just had five up months in a row (up about +12% in that time in 2019 Jan to May) ie.

  • May +1.13%
  • April +2.34%
  • March+0.19%
  • Feb +5.19%
  • Jan +3.87%

The last time we had five months up in a row

  • from March 2018 to Aug 2018 where the ASX 200 rose +9.78%
  • the following month - Sept 2018 the ASX 200 dropped -1.77%

I had a look at the “Index Impact” this year vs last few years - to see the Index Impact that tax loss selling could have on the market (ie. how much could it cause the ASX 200 to fall).

Three years ago (2016)

  • Three years ago we saw there were 71 stocks that were down - but they made up a whopping 56% of the ASX 200as a result we saw the ASX 200 at its low in June 2016 down a massive -6.1%.
  • It rallied hard in the later part of June (as I think it will again this year) to close June down -2.7% (and then went on in July 2016 to be up +6.30% - the reason I mention this is that the June lows can be a good short-term buying opportunity).

Two years ago (2017)

  • Two years ago the weighting of the 77 stocks that were "down" was insignificant at just 17% of the ASX 200 - so the selloff in early June was only small at -0.78% (what helped then was May had fallen -3.37% that took the "weight" of the fall early).
  • So in June 2017 we saw the ASX only down (just) -0.05% ... BUT the July bounce just lacked follow through that year & ASX 200 was down again (just) -0.02%.

Last year (2018)

  • One year ago the weighting of the 66 stocks that were "down" was large – (but not that massive) at 40.7% of the ASX 200 - so the selloff in early June was very small last year with a low of just -0.64%.
  • So in June 2018 the tax loss selling didn’t impact the ASX 200 as the ASX 200 itself was up about +5.4% for the financial year to May - thus we saw the ASX ended up rallying nicely, closing up +3.04% ... & then July (usually a strong month) continued the rise, up +1.38%.

A major reason why the market tends (most years) to sell off in mid to late May to mid June is because of the tax loss selling

  • This comes as investors crystallize capital losses before the end of the Australian tax year that ends on 30 June 2019.
  • But also instos clean their books & in some cases completely dump a holding so that they do not own it by 30 June.
  • This usually applies particularly to high-profile disasters – because when instos publish their portfolio in the annual report – showing exactly what stocks they held on 30th June 2016 ...
  • They don’t want shareholders or clients to focus on a “bad holding” – which we all know they will.

Cut and run ...

  • Pact Group for instance (down -57%) in 2019 or Eclipx (down -64.7%) were ones instos don't want anyone to know they still own.
  • Or a crowd favorite - Costa down -52% - was one that most instos were in & loved it - so many got rid of them, so that it didn't appear in their end of year (June 30) reports.
  • Better to cut & forget rather than explain why you owned any of these three!

Now I have looked at tax loss selling over the years & it actually begins earlier than most realise – around mid May .

  • It usually goes for four weeks until the second/third week of June & then some stocks start to recover.
  • Now looking at this year the ASX 200 since June 30 last year (to 31 May 2019) is up +3.26% - so as a result the tax loss selling will not be that bad on the ASX 200.
  • Of the ASX 200 stocks 100 are down while the other 100 are up.
  • So this year we have 50% of stocks lower - so there could be a number of stocks being hit across the board.
  • 72 stocks are down -10% or more.

This year vs last year are very different - looking at market weight of the tax loss stocks

In 2016

  • We saw of the ASX 200 only 35% of stocks that were lower – a large number of stocks that are heavily weighted in the index.
  • Of those 71 stocks or just 35% of the ASX 200 stocks – they made up in 2016 56% of the ASX 200  that was significant & was a big reason the index was down -6% at its June 2016 low.

In 2017

  • The weighting of the 77 stocks was insignificant at just 17% of the ASX 200 - so the selloff was not as bad as 2016 & in fact the ASX 200 closed down just -0.05%.
  • be anywhere as bad as last year.

In 2018

  • The weighting of the 66 stocks was significant at 40% - but that year the ASX 200 ended up stronger +3%.

In 2019 - this year

  • The weighting of the biggest number of stocks I've seen in a long time, 100 stocks, is significant at 39.7% of the ASX 200 - so the selloff in early June I believe this year - will still come.
  • Also after five months up in a row (+12%) this could be the tipping point for some selling.
  • The major influence of the ASX 200 will be more when the US has its traditional June weakness & drags us lower.
  • But there is another massive (in my view) influence that should see the market very strong in the last two weeks of June - I'll look at that next week.

This table shows all the 100 stocks (in the ASX 200) that are down so far this financial year (to end of May)

Source Coppo report

The Small Ords is very similar to ASX 200 with just 39.3% of the Small Ords stocks down

This shows all the 101 stocks (in the Small Ords) that are down so far this financial year

Source Coppo report

Quant funds will have shorted some tax loss stocks already

  • Quant studies show that shorting potential tax-loss selling stocks during late May has generated positive alpha in 20 out of the past 22 years.
  • This comes usually from three tension points -

(1) instos selling tax loss stocks

(2) retail investors selling tax loss stocks &

(3) hedge funds “shorting” tax loss stocks.

Most begin selling in late May

  • This can be a bittersweet time – but only if you sell late May & buy back in before July (that’s assuming you want to buy back in – in many cases sell & stay away).
  • In the past whenever we see tax loss selling it usually begins early, as the instos move “ahead of the pack” and start their tax loss selling from late May.
  • The more illiquid the stock – the greater will be its fall over June.
  • So any liquid stocks you want to sell – do it early, because everyone else comes in over June.
  • And the most "illiquid stocks" are the Small Cap ones - so these also present the greatest opportunity of they get smacked hard in the next two to three weeks ...

Many don’t think about this until early/mid June

  • In May you are not thinking about tax time, but come June you begin to think – I’d better lock in those tax losses now before June 30.
  • So over the years we tend to see many stocks (especially the illiquid ones) have really big falls that begin in late May & usually goes until the second or third week of June.
  • Many of these stocks bottom around then & then start what can be in some cases really big recoveries that go from mid/late June usually until the third week of July BUT then some of these stocks then fizzle out & can fall all the way back (if crappy stocks) .

History shows big caps & small caps fall on tax loss selling

  • What is also worth highlighting is that quant studies prove all this – as these tax loss stocks underperform the market by significant margins in June.

The large caps by -2.5% & the small caps by -5%

  • BUT what is of even more significance, looking at the last 20 years of tax loss selling, when the big caps are down -10% or more, then they have actually fallen another -2.5%.
  • This financial year, of the ASX 200 stocks that have fallen -10% or more we have a large number of stocks with 77 stocks - BUT they only make up 14% of the ASX 200.
  • So that takes a lot of the "sting" out of the overall impact that these stocks will have on the ASX 200.

So the big cap ones that may go lower - as retail sells could be:

  • Scentre Group
  • IAG
  • Origin
  • Treasury Wines
  • Oil Search
  • Lend Lease
  • Hardies
  • Caltex
  • Boral
  • AMP
  • Challenger
  • Bluescope
  • Dominos
  • CYBG

ASX 200 stocks that have had biggest falls of over -10% or more, in the last 11 months to 31 May (this financial year ie. since 30 June 2018) are ...

Source Coppo Report

But the Small Ords could see many stocks hit as well & there will be some great buying in many

  • In the Small Ords there are 84 stocks that are down -10% or more, that could fall an additional -5% (or more ) in June.
  • Hence the Small Ords would normally suffer more in the next three weeks - but given these 84 stocks make up almost 1/3 of the Index or 30.67% to be exact ...
  • So on that I expect to see the the Small Ords Index underperform the ASX 200 in June.
  • But with these stocks below I think this should be the last "wash out" for some in the next few weeks & this is where their outperformance can rise from.
  • Their time in the sin bin could be over in just a few weeks.

Small Ords stocks that have had the biggest falls in the last 11 months (this financial year since 30 June 2018 to 31 May 2019).

Source Coppo Report 


Get more insights from the insto desk in the Coppo report

This article is based on excerpts from The Coppo Report contributed to Livewire by Richard Coppleson, Director - Institutional Sales and Trading, Bell Potter. You can find out more by clicking here.

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Comments

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A. Ozaydin

In addition to Tax selling, there have been Technical and seasonal reasons too (DJI and ASX 200 double topped early May, 125 day Cycle Topped early May and infamous Sell in May And Go Away phenomenon).