A trading strategy with a strong track record has allowed investors to profit from indiscriminate selling during U.S. tax-loss selling season. Here, for your consideration, is this year’s list of 14 stocks that fit the pattern.
The process of tax-loss harvesting involves selling underperforming stocks to lock in a loss that can be used to offset taxable income elsewhere. In a recent research report, Merrill Lynch quantitative strategist James Yeo showed that, in cases where companies are likely to be targets of tax-loss selling but retain solid profit outlooks, investors can generate significant returns by buying their stocks at depressed levels.
Mr. Yeo’s analysis identified tax-loss selling candidates as those down more than 10 per cent in the first 10 months of the year, yet which remain buy-rated by Merrill Lynch analysts. Looking at data going back to 1986, he calculated that the average return for these stocks in the November to January period was 5 per cent, 1.4 percentage points higher than the S&P 500’s average 3.6 per cent.
Importantly, the success rate for this trading strategy was very high. Merrill Lynch found that the underperforming stocks outperformed the S&P 500 70 per cent of the time over that November to January period.
The research report identified 14 stocks that qualify for the trading strategy, shown in the accompanying table. If the historical track record is repeated, 10 of them should outperform the benchmark in the next three months. All of the stocks are buy-rated by Merrill Lynch analysts.
The energy sector is most prominent on the list of trade ideas, providing about a third of the names. The remainder are split between the technology, materials, communication services and consumer industries.
The best way for investors to use the list is to find a company they wouldn’t mind owning on a fundamental basis. In my case, F5 Networks Inc. is a stock I’ve generated profits with before – I was attracted to the company’s role in the continuing corporate evolution to cloud computing. I’ll be taking a careful look at F5’s current business outlook and be watching for tax-loss selling to provide a lucrative entry point.