Michael Santoli

Time to Shop for Beaten-Down Stocks Primed to Bounce

This has been one of the harder years in recent memory to lose money buying American stocks. But the unlucky holders of several dozen clunkers managed this trick pretty nicely.

While the broad stock market has gained more than 25% for 2013 and nearly every sector has delivered positive returns, pockets of profound weakness now feature some 50 large- and mid-capitalization stocks down more than 10% year-to-date. The small-cap Russell 2000, with a wider sample of volatile and untested companies, had at least 50 stocks shed more than 40%.

Behavioral-finance experts tell us holding on to losing stocks while wishing for a comeback is among the most deeply ingrained mental traps humans and their money fall into. Year-end tax-planning sessions are where hope often goes to die, as investors are motivated to sell underwater stocks to reap losses that can offset capital gains they have booked.

This tends to lead to further pressure on already-weak stocks in December, followed by a pronounced, mechanical bounce in January. This is one major source of the enduring “January effect,” in which smaller, riskier stocks tend to outperform at the start of a year.

The Time Is Now

So now is probably time for contrarian, opportunistic investors to start putting together a shopping list for stocks that could become “sold out” and primed for a rebound come late December and January. This year it will help if bottom fishers have a taste for commodity-related stocks, real estate investment trusts, beaten-up network-gear plays and some “broken” retail chains.

Some market observers are saying this could be a particularly active year for such tax-driven loss-harvesting, given how high the indexes have traveled and considering the stupendous gains in a handful of widely owned names such as Netflix Inc. (NFLX), LinkedIn Corp. (LNKD), Facebook Inc. (FB) and Best Buy Co. (BBY). Anyone booking lush profits in these favorites will likely want to generate some losses to offset capital gains and blunt his or her tax liability.

A fair amount of whatever tax-loss selling might occur is probably already through. There is no precise date at which this sort of activity needs to start and it can be done well before year-end. So some of the affected stocks could already have gotten washed out. The usual pattern is for tax-loss liquidation to peak in mid-December.

Patrick O’Hare, chief market analyst at Briefing.com, ran a screen for all stocks in the Standard & Poor’s 500, S&P Mid Cap 400 and small-cap Russell 2000 with a negative return this year and average trading volume of at least 50,000 shares.

The S&P 500 losers list is thick with basic-materials and mining plays, victims of the weakness in commodity prices and cooling of Chinese and emerging-market industrial demand. Newmont Mining Corp. (NEM), Cliffs Natural Resources Inc. (CLF), Peabody energy Inc. (BTU) and Mosaic Co. (MOS) are down between 49% and 17%.

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The chart for each stock is, naturally, pretty soiled, but that’s the way it is with dumpster-diving investment tactics. Each would fit with an outlook for improved sentiment on global industrial growth in 2014, of course.

REITs were white-hot heading into the year, riding a multi-year win streak as investors binged on yield stocks. They have suffered in 2013 due to upward pressure on bond yields making their payouts appear less enticing, along with rich valuations.

A few on the discard heap into year-end are Avalonbay Communities Inc. (AVB), Mack-Cali Realty Corp. (CLI) and Taubman Centers Inc. (TCO). Each yields 3% or more, which may or may not count as attractive depending on how rates react to an expected ebbing of Federal Reserve asset purchases into 2014.

 

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A clutch of computer-network and data-services plays have suffered, too, amid soft corporate-technology spending and unexpected weakness in emerging markets this year. Notably, Broadcom Corp. (BRCM), JDS Uniphase Corp. (JDSU) and Citrix Systems Inc. (CTXS) were all double-digit percentage losers in an otherwise strong Nasdaq tape.

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Wayward chain retailers that have lost customer loyalty are among the bottom-dwellers, too, include Abercrombie & Fitch Co. (ANF) and – of course – JC Penney Co. (JCP). The latter has recovered nicely lately, jumping more than 60% from its late-October low of $6.42, now that it says it will have ample cash through the holiday season.

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Activist investor Bill Ackman of Pershing Square Capital sold his entire 18% Penney stake over the summer at a big loss at prices above $12 a share. Any other investors who have ridden the stock down and want to collect some useful tax losses will likely do so in the next couple of weeks no doubt selling their shares to believers in Penny's intriguing long-shot turnaround prospects.

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