OFF TOPIC: TAX SELLING
<<<<Funds' Tax-Related Selling May
Rattle Markets and Tech Stocks
By Ian McDonald
Senior Writer
9/26/00 11:44 AM ET
William Faulkner said, "The past is never dead -- it is
not even past." Since one in three U.S. stock funds
operates on a fiscal year that ends in either September
or October, the past -- as in fourth-quarter 1999 -- may
haunt the market, and many once-hot tech stocks in
particular, in the next few weeks.
As mutual funds near their fiscal year-end, portfolio
managers often dump losers to offset the distribution of
taxable capital gains -- incurred due to price
appreciation of highflying stocks -- to their shareholders.
At the same time, many fund managers also build or
expand positions in this year's winners so that they
feature prominently in their reports to shareholders -- a
practice known as window dressing. With many funds
sitting on fat gains from the end of last year as fiscal
year-ends loom, housekeeping by managers might be
more stark than usual.
The upshot: You might notice some deep downdrafts for
sagging stocks such as Intel (INTC:Nasdaq - news) and
Yahoo! (YHOO:Nasdaq - news), and some unusually
sharp run-ups for winners.
"There's a lot of market maneuvering by a small number
of people that control a lot of dollars," says Scott Bleier,
chief investment strategist at Prime Charter. "Stocks
go up and down a lot faster while mutual fund guys do
what they have to do."
The potential market reverberations have their roots in
the euphoria of the fourth quarter of 1999. Last year,
more than 185 stock funds posted returns of more than
100%, averaging a stunning 146% as a group. Before
1999, there hadn't been a calendar year when the
Century Club had even 10 members. Many of those
funds notched their biggest gains the fourth quarter,
although a number have cooled this year.
Blast From the Past
Many funds -- like their benchmarks --
reaped most of the past 12 months' gains
in last year's fourth quarter.
4th Quarter
1999
1-Year
Returns
Technology Funds
62.6%
71.5%
Telecommunications
Funds
36.7
26.8
Average U.S. Stock Fund
18.1
24.8
Nasdaq Composite
48.2
38.3
S&P 500
14.5
13.1
Source: Morningstar and Baseline. Performance through Sept. 25.
That means many fund managers with fat gains on their
books are scrambling right now to sell losers and reduce
their shareholders tax burden. When a fund realizes
more gains than losses, it's required to distribute those
gains to shareholders, sometimes leaving them with a
painful tax bill even if they reinvest those gains in the
fund. Of course, investors in tax-deferred retirement
accounts are immune.
These last-ditch efforts to minimize capital gains
distributions is good news for fund shareholders,
especially if they bought their shares recently. A big
payout leaves them paying taxes on other investors'
gains.
Already this year we've seen early and steep
distributions from Warburg Pincus and Legg Mason.
Even big shops such as Vanguard are warning
shareholders that larger-than-usual gains are on the way
from some funds.
"If you've got a fund with killer returns from last year
that's down this year, you'd better hope they're doing
some tax-selling. You're probably looking at some big
profits from December, January and March, but since
then a lot of hot stocks have sold off ferociously, so it
makes sense for managers to do some tax-selling to try
and reduce that tax hit," says Russell Kinnel, director of
fund analysis at Morningstar.
Kinnel says that despite these efforts, plenty of funds
"still have the chance to make some big distributions."
But the real potential victims of these machinations
might be stock investors. Between window dressing and
tax-loss selling, some stocks might be unreasonably
jerked around between now and the end of the year.
"Year-end tax loss selling tends to take stocks that are
already weak and add on further losses. The result of
this selling wave is that fundamentally sound companies
come under pressure along with weaker names," writes
Salomon Smith Barney equity strategist Jeff Warantz
in a Sept. 21 report.
Of course, in the aftermath, investors could profit from
knowing which stocks were being oversold -- sold more
for tax reasons than qualitative decision-making. But
that's a tough list to figure.
"Window dressing and tax-selling are perennial, but it's
hard to know what stocks will get hit. They don't have to
be down for the year, just down," since the fund
purchased the shares, says Don Luskin, manager of
the OpenFund and the Metamarkets.com IPO & New
Era fund. "Stocks have been so volatile this year that,
given the chaos we've seen, any stock could be a winner
or a loser."
In his report, however, Salomon Smith Barney's Warantz
takes a stab at some potential losers. He screened the
market for companies that have a buy rating from
Salomon Smith Barney analysts, a market capitalization
over $2 billion, a stock price down at least 20% from its
52-week high, and rising earnings projections over a few
different time periods. The screen came up with a dozen
stocks, all in the tech and Internet sectors.
Naming Names
A Salomon Smith Barney report
targets these tech companies as potential victims of
fiscal year-end tax-related selling.
Intel (INTC:Nasdaq -
news)
QLogic (QLGC:Nasdaq -
news)
Yahoo! (YHOO:Nasdaq -
news)
Art Technology Group
(ARTG:Nasdaq - news)
Micron Technology
(MU:NYSE - news)
priceline.com
(PCLN:Nasdaq - news)
VeriSign (VRSN:Nasdaq -
news)
Lam Research
(LRCX:Nasdaq - news)
Altera (ALTR:Nasdaq -
news)
Symantec (SYMC:Nasdaq -
news)
KLA-Tencor
(KLAC:Nasdaq - news)
Credence Systems
(CMOS:Nasdaq - news)
Source: Salomon Smith Barney from a Sept. 21 report.
There's reason to give this list a close look, since many
of these potential losers could come back in a hurry
once the funds stop their tax-related selling. The firm ran
a similar screen last year that turned up 11 stocks that
looked vulnerable to tax-related selling near the end of
'99. The stocks, collectively, have outperformed the S&P
500 since the list was drawn up. >>>>
Best wishes,
Jim |
