As 2024 unfolds, a notable trend is emerging among investors, particularly concerning their underperforming stocks. Tax loss harvesting, a strategy where investors sell losing investments to offset gains elsewhere, is set to accelerate as the year approaches its conclusion. This phenomenon, combined with ongoing macroeconomic challenges, could lead to further declines in already struggling stocks, as highlighted by Morgan Stanley’s recent analysis. Investors are urged to pay close attention not only to immediate market movements but also to the broader consequences that these decisions may impose on various stocks.
October has seen considerable volatility in the stock market, attributed to geopolitical uncertainties in the Middle East and surging oil prices, which have frazzled investor confidence. Despite this turmoil, both the S&P 500 and the Nasdaq Composite have experienced impressive gains throughout the year, surpassing 20%. As the fourth quarter begins, many investors are re-evaluating their portfolios, weighing the merits of holding onto winning stocks against the potential benefits of realizing losses on underperformers. This is where tax loss harvesting enters the conversation.
Tax loss harvesting allows investors to offset capital gains with realized losses, thereby trimming their taxable income. Should losses exceed gains, individuals can use up to $3,000 of those losses to reduce their ordinary income on federal tax returns, a strategy that can be extremely beneficial for tax liability management. This practice becomes increasingly vital as investors seek to optimize financial outcomes in an uncertain economy.
Morgan Stanley’s strategy for identifying stocks poised for tax loss selling involved analyzing the S&P 1500 for securities that were top-rated at the beginning of the year but have since declined significantly in value—specifically, those that have dropped at least 10% from January to September. This method is particularly insightful, as it indicates stocks that investors have been reluctant to divest despite clear underperformance.
The analysis pointed out that stocks identified for tax loss selling generally trail the broader market. Morgan Stanley reported that these stocks underperformed by an average of 178 basis points in October alone. This discrepancy directly suggests that a self-reinforcing cycle may be at play, whereby investors’ selling behaviors exacerbate the downward trend of these stocks.
Among the stocks that may experience increased selling pressure is Adobe, which has already faced a challenging year, exhibiting a 17% decline. Analysts, including KeyBanc’s Jackson Ader, have expressed skepticism toward Adobe’s future performance, and this sentiment is underscored by disappointing fourth-quarter guidance. Specifically, there are concerns about lower-than-expected digital media revenue projections, which could prompt investors to reconsider their holdings and potentially contribute to deeper price declines.
Boeing, a stalwart in the aerospace sector, has similarly faced scrutiny amidst a staggering 40% decline in 2024. The company has grappled with significant operational issues, including a severe manufacturing error related to its 737 Max aircraft and ongoing labor disputes. Bank of America analyst Ronald Epstein highlights a shift in Boeing’s status from a celebrated American manufacturer to a company mired in crisis, further signaling that tax loss selling could amplify its stock challenges in the near term.
Halliburton, another name called out by Morgan Stanley, has seen a drop of about 17% this year. Analyst Keith Mackey’s downgrade reflects underlying concerns about the company’s revenue diversification, which may result in greater earnings volatility, especially in uncertain economic climates. This situation creates a perfect storm for tax loss harvesting, as investors are likely to seek exit strategies to shield their portfolios from further losses.
As the end of the fiscal year approaches, investors across the board must navigate the complexities of the tax landscape in conjunction with tumultuous market conditions. The implications of tax loss harvesting extend beyond immediate tax savings; they signal broader trends in market psychology and investor behavior. While selling off underperformers might seem prudent to some, it could inadvertently lead to a cascading effect that further depresses these stocks.
As investors become increasingly committed to tax loss harvesting, they must also consider the potential consequences for their portfolios and the market at large. The reality is that while it may provide short-term benefits, the long-term effects could be more complex than anticipated. Investors should approach these decisions with caution and strategic foresight, ensuring they are not simply reacting to current market dynamics but instead plotting a sustainable course for future growth.