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Tax Selling, Profit Taking Weaken SPY, QQQ, IWM

Jeff Hirsch

By Jeffrey A. Hirsch

We have all been made painfully aware of what a great month for the stock market December has been over the years. (I take full responsibility for propagating much of this statistic.) However, I may have been remiss in specifying how most December’s outperformance tends to come in the latter half of the month.

Today’s decline on weak economic data, stalled budget talks in Washington and continued uncertainty on the Eurozone sovereign debt woes, dampened the usually bullish trade on the first trading day of December. In fact, the first 3 trading days of December are historically quite bullish.

But after the first 3 days the tax-loss selling begins to intensify and money managers ramp up profit taking in an effort lock in gains for the year and beef up their yearend numbers. This is often a drag on the equity markets through mid-December.

Toward the end of the month selling gives way to a buying bias that has moved much of the so-called “January Effect” of small cap stocks outperforming large caps in January into the last two weeks of December and is responsible for creating the vaunted Santa Claus Rally.

The following charts illustrate this quite clearly. The bar charts are our Market Probability Charts the show the percent of time the index was up over the previous day from 1991-2011. This line chart is the average performance since 1979 when the Russell Index data begins.