Can anything good come from something bad? It’s a philosophical question that has practical application for investment advisors and the clients they serve.
Although the U.S. stock market has largely been good in 2017, buried beneath the strong gains are a few stock market losers packed with plenty of bad. How can advisors turn identifying and dumping stock market losers into a winning proposition?
The first step is to identify which industry sectors within the broader stock market are underperforming. Why? Because lurking beneath that sector underperformance are stocks within the same industry group likely to have sub-par returns.
Most of this year’s losing stocks have been concentrated in the energy sector. The Energy Select Sector SPDR ETF (XLE), which tracks 32 energy companies within the S&P 500, has declined 7.46 percent year-to-date. Moreover, some top components within XLE like Halliburton, Kinder Morgan and Schlumberger have recorded yearly losses ranging from 10 percent to 22.16 percent. Each of these companies is a good candidate for tax-loss selling.
After identifying losing positions, the next step is to match them up with stocks that have realized capital gains. The purpose is to offset the gainers with the losers in order to reduce a person’s 2017 tax liabilities. Also, by selling a losing stock investors may be able to offset any taxes on income. ETFs play an important role in the tax-selling process because they allow the investor to replace the loser they just sold with similar market exposure without violating the Internal Revenue Service’s 30-day wash sale rule.
For example, selling a loser like Halliburton and replacing it with XLE avoids the risk of running afoul of the wash-sale rule. Additionally, it provides similar exposure to the energy market, which reduces investor anxiety about missing out on future gains that might occur in this sector.
Meanwhile, certain stock market losers might be hiding in industry sectors with excellent performance. The Industrial Select Sector SPDR ETF(XLI), for example, has gained 16.56 percent while one of its major components, General Electric, has slid 34.50 percent.
“When we launched Sector SPDRs 18 years ago, GE was the largest industrial stock in the index and was for 18 years until last week,” says Dan Dolan, director of wealth management strategies at Select Sector SPDRs. “Over time the value of GE has come down and the other industrials like Boeing and 3M are now bigger than GE on a market-cap basis. GE is the perfect candidate for a tax swap.”
While it’s always a psychological challenge to unload a loser—especially a widely owned stock like GE—exchanging it for a basket of world-class industrial stocks, which GE is still a part of, makes it more palatable.
Another tax-loss selling candidate is former highflier Under Armour. The beleaguered sportswear company reported its first operating loss ever during the first quarter of the year and its share price has cratered nearly 57 percent. Meanwhile, its peer industry group represented by the Consumer Discretionary Select Sector SPDR ETF (XLY) has gained 14.09 percent since the start of the year.