::by SmartInMoney:: Historically stocks of small-cap companies had seasonal tendency of outperforming the large-caps around the turn of the year, specifically during January. The existence of this January Effect of stock market return has been widely known. In back testing, researchers have found that it existed in many prior decades.
There are some theories behind this stock market anomaly. Two possible explanation on the January effect are that investors’ activity of buying back into beaten-down small-caps, which were probably sold at losses for tax and window dressing reasons late in the outgoing year. Others speculate that the phenomenon has something to do with less information flow of small cap stock during the year.
Window Dressing
The January Effect phenomenon may happen because of investment managers’ eagerness to invest in riskier stocks in January than in December. We often observe artificial selling pressures that come from portfolio window dressing in December.
It has to do with the benchmark that managers must outperform for their year-end success. The most commonly used benchmark is the large cap S&P 500 index. As a more speculative play than the S&P 500, small-cap stocks have a greater possibility of larger than average returns and losses. Therefore, at the beginning of a year, if small-cap stocks receive a good push, it can put fund managers well ahead of their respective benchmarks. If managers gain a lead, then they could simply mimic the S&P 500 for the remainder of the year and come out ahead.
Consider a manager who is ahead of the S&P 500 for year-to-date performance as the end of the year approaches. To hold on to his lead above the S&P 500 until Dec. 31, he will have an incentive to make his portfolio look more and more like the S&P 500. That means he will tend to shift money out of stocks that are not part of the S&P 500 and into the large caps that dominate that index.
Investment managers who are only moderately behind the S&P 500 as the end of year approaches also will have an incentive to reorient their portfolios to be more like the S&P 500. Their fear of losing their bets and lagging the S&P 500 by an even large margin motivates them to take less risky approach.
The managers are more likely to dump their losers over weeks prior a year end for window dressing. These investors are going to want to get the most controversial stocks out of their portfolios soon so that the names won't show up in their year-end reports. And, of course, losing positions are always much more controversial than winners.
Come New Year's Day, concerns about year-end reports will disappear. Managers willingness to take risk will be at the highest point it will be all year. Appetite for higher risk often manifests as an eagerness to bet on small-cap stocks. Furthermore, many of the stocks that were being dumped in December will suddenly look quite attractive when investors once again focus on fundamentals. Those in turn mean that managers in January will likely be net sellers of the large caps that they increasingly purchase in November and December.
Tax Loss Harvesting
We also often observe artificial selling pressures that come from tax-loss selling in December.
For taxable investors, market movements both in the broad market and in particular sectors over the course of the year may leave investors with both big winners and big losers in their portfolios. If they want to cash out their winners, they are likely to sell losers as well to offset the taxable gains from the winners. This approach is known as tax-loss harvesting.
Same as what happens in window dressing, concerns about taxes will disappear as New Year's Day comes; and many of the stocks that were being discarded in December will look quite attractive when focus is aimed on fundamentals.
Information Flow
Others speculate that the January effect is most pronounced among small-cap stocks because of information flow of the small-cap stocks. There's generally less information available regarding small stocks, and much of the news tends to be released at the end of the year. Thus, investors may be best informed and ready to buy small caps in January.
Caveat
Abnormal market condition around the turn of the year influences January Effect strategies. If investors panic around the turn of the year and there is a market-wide flight to quality as what happened in December 2008, the January Effect strategies were not appealing. While both large caps and small caps declined, small caps suffered the most. As a result, January Effect strategies turned a loss in January 2009. Investors have learned that no matter what has happened in the past, the future is just too hard to predict
January effect has became weaker in the recent period, since 1970, would be explained by the activities of investors who try to take advantage of the anomalous behavior of stock returns.
Tracking January Effect
Investors can tell if a January effect is under way this year by comparing the performance of small-cap stocks to large-caps stocks. A simple method of doing this is to compare the following two exchange-traded funds: the iShares S&P 500 ETF (IVV) and the iShares Russell 2000 small-cap ETF (IWM).
Betting on the January Effect
If you are willing to make that bet, exchange traded funds probably provide the easiest investment vehicles with which to do so. You would purchase an ETF that invests in small-cap indexes, such as the iShares Russell 2000 fund (IWM) or Vanguard Small Cap (VB), while simultaneously shorting an equal dollar amount in an ETF that invests in the S&P 500, such as the iShares S&P 500 fund (IVV ) or Vanguard Large Cap (VV).
Not all January Effect strategies use the same entry and exit dates. A study used Dec. 20 as the entry (or the close of the first trading session after Dec. 20 if the market was closed on that day), and Jan. 9 as the exit.
::by SmartInMoney:: From a tax standpoint, dumping losing-money security prior a year end is not a bad idea. The tax advantages of setting your gains against your losses can be enormous as long as you follow all the rules and implement a few tricks of the trade.
Tax-loss harvesting, also commonly known as tax selling, is one of the ways to avoid taxes on some of your portfolio gains. Tax-loss harvesting is the selling of securities, usually at year-end, to realize portfolio losses, which an investor can use to offset capital gains and therefore lower personal tax liability.
Tax Treatment of Gains
If you, like many others, own shares of a mutual fund, you are most likely subjected to some type of year-end payout. This could be in the form of a dividend, interest payout, short-term capital gain or long-term capital gain. Now, if the security giving you the payout is in a taxable account, then Uncle Sam will be sure to want a piece of the pie come tax time.
For tax-reporting purposes, the short-term gains and losses (those made in one year or less) are first netted against each other for the tax year; then long-term gains and losses (those made in more than one year) are netted; and finally the remaining outcomes are combined together.
In any given year, there is no limit on the amount of capital losses that can offset capital gains. However, only a maximum of $3,000 net loss can be deducted from ordinary income; any excess loss may be carried forward into future tax years. The carry-forward loss must maintain its definition as either a short- or long-term loss. If you and your spouse file separately, the maximum capital-loss deduction limit is $1,500 per spouse, not $3,000 each.
The Wash Sale
With the wash-sale rule, the IRS disallows a loss deduction from the sale of a security if a ‘substantially identical security' was purchased within 30 days before or after the sale. The wash-sale period is actually 61 days, consisting of the 30 days before and the 30 days after the date of the sale. The wash-sale rule is designed to prevent investors from making trades for the sole purpose of avoiding taxes.
For example, if you bought 100 shares of Google on December 1 and then sold 100 shares of Google on December 15 at a loss, the loss deduction would not be allowed. Similarly, selling Google on December 15 and then buying it back on January 10 of the following year does not permit a deduction.
Selling an S&P 500 index fund and then immediately buying an S&P 500 index fund from a different company is a grey area. Due to the IRS vagueness on wash sales and mutual-fund trading, you'll likely encounter no issues with the deductibility of a loss resulting from this type of transaction. However, many tax professionals will advise to avoid the situation if possible.
Strategies
Here are some strategies and rules to keep in check when implementing tax-loss harvesting:
• If you want to stay in the asset class, you can purchase a similar but not substantially identical security immediately after the tax-loss sale of your original position.
• If, after selling the security and realizing the capital loss, you still believe that the security is a keeper, wait the 31 days for the wash-sale period to elapse, and then repurchase the original security.
::by MYVOICEOFLIFE.BLOGSPOT:: Surprising job market improvement adds confidence on the economic recovery. The U.S. unemployment rate went down to 10 percent from a 26-year high of 10.2 percent while only 11,000 jobs disappeared in October. This is the best economic news since the current recession began two years ago.
Although 15.4 million people are struggling to find work, the November report revealed signs of improvement across the country. More than 50,000 temporary workers were hired, the first surge in months and often a precursor to companies hiring permanent workers. Employees worked more hours, even in manufacturing.
The bright jobs report suggests that an end might be in sight for huge stimulus efforts and rock-bottom interest rates. It suggested to investors that the Federal Reserve might lift interest rates sooner than analysts had expected. Higher interest rates mean more lucrative returns for investors who hold dollars.
A strengthening dollar lured investors away from the stock market on Friday. As investors snapped up currencies, giving the dollar one of its best rallies of the year, stocks stumbled and spent much of the day meandering between gains and losses before ending the day in positive territory.
Many forecasters suggest that the turning point, from jobs being cut to jobs being added, will come by March, assuming the economy continues to grow, as it finally started to do in the third quarter.
2007 to 2009 Episodes
::by SMARTINMONEY:: After more than two-year financial malaise, signs of recovery finally emerged in 2009 as the economy expanded for the first time in a year in October and stock markets surged above 50% from their the bottom in March. A major challenge to a full recovery is the struggling labor market with a 10.2% unemployment rate.
Housing bubble burst and subprime mortgage disaster in 2006 led to a series of stunning financial closures. They changed the face of Wall Street forever, turned the United States economic to the most serious crisis since the Great Depression, and eventually sent the global financial system into turmoil in the fourth quarter 2008.
Precursors: Housing bubble build-up
The precursors of this crisis went back as early as 2000 when the tech bubble burst, followed by the Fed’s lowering interest rates to stem the recession. Lower interest created the housing boom, ensued by the period of careless mortgage lending and the complex financial instruments to slice up and resell the mortgage-backed securities intended to spread risk.
As the quality of the mortgages went down, subprime mortgage and loans default and delinquency rate began to rise in 2006.
2007: The crisis began with subprime mortgage bubble burst
As a result of the rising number of foreclosures and mortgage backed securities defaults, in June 2007 two Bear Stearns hedge funds that had invested heavily in the subprime market collapsed.
More banks found that securities they thought were safe were tainted and became toxic mortgages. At the same time, the number of prime mortgages in default increased, and the rising number of foreclosures facilitated speed of the fall of housing prices.
For the first time in over a year, the Fed cut the Federal Funds rate by 50bp to 4.75% to prevent a steep housing slump and turbulent financial markets from triggering a recession.
2008: Gloomy year for U.S. and world economy
As Wall Street’s losses mounted, in March 2008 the Fed staved off a Bear Stearns bankruptcy by assuming $30 billion in liabilities and engineering a sale to JPMorgan Chase. The government-engineered sale of Bear set off a new phase of financial turmoil and Wall Street’s meltdown.
In the fall of 2008, problem is the credit markets ballooned into Wall Street’s biggest crisis since the Great Depression. The financial turmoil began to accelerate in September 2008 and eventually turned into a full-blown global financial crisis.
During this biggest financial crisis since the Great Depression, the U.S. government had to rescue the nation’s two largest mortgage finance companies, Fannie Mae and Feddie Mac, and bailed the troubled insurance giant A.I.G. out. Lehman Brothers went bankrupt and Merrill Lynch was sold to Bank of America. The Lehman Brothers bankruptcy marked the largest bankruptcy in U.S. history, with more than $600 billion of debt.
Mighty investment banks that once ruled high finance crumbled or reinvented themselves as humdrum commercial banks, which is subject to tighter regulation, in exchange for more access to the Federal Reserve's lending facilities. The channels of credit, the arteries of the global financial system, constricted, cutting off crucial funds to consumers and businesses small and large.
As global stock markets plummeted and economies shrank, many currencies sank. The unemployment rate jumped as million of jobs evaporated. America and Europe reacted to the crisis by unveiling broad bail-out packages for the financial system. The U.S. government passed a $700 billion financial bailout package and the Fed made unprecedented market interventions, such as buying large amounts of short-term debt issued to companies to enable day-to-day financing and to rejuvenate a reeling economy.
Most central banks slashed interest rates. By the end of 2008, the Fed had cut its target for the overnight federal funds rate to near zero (range of zero to 0.25 percent) and brought the U.S. to the zero-rate policies.
In December 2008 America was officially declared to have been in recession since December 2007; and Japan and the euro area fell into recession (using the definition of two quarters of negative growth). The IMF, World Bank and OECD snipped their projections for economic growth next year.
At the end of 2008 authorities arrested money manager Bernard Madoff, a onetime Wall Street legend. He was charged with running the largest Ponzi scheme in financial history, a $50 billion fraud that wiped out many investors.
Over the last 12 months that were ruled by negative economic indicators and widespread fear, the S&P Index decreased about 40 percent, for a loss of more than $6 trillion.
(Read “A kaleidoscope of the critical events in 2008”)
2009: Year of recovery
In the beginning of 2009, the U.S. government adopted a $787 billion economic stimulus measure to beef up the ailing economy. As the unemployment rate surged to 8.1 percent, stock markets hit the bottom in March.
At the end of second quarter, ten big banks began to exit bailout program by repaying federal aid that had sustained them through the worst of the economic crisis.
Signs of a recovery began to emerge in August. Positive economic data across the globe offered a hint that the worst of the financial crisis had passed, though many cautioned that the after-effects were likely to persist for quite some time.
The third quarter probably marked the end of the longest recession since World War II, with the economy expanding at an annual rate of 2.8 percent for the first time in a year. The report does not mark the official end of the recession, though. That determination will be made by the National Bureau of Economic Research, likely sometime in 2010 once all the various economic readings have had their final revisions.
As the economy emerges from its deep recession, labor market continues to struggle with the U.S. unemployment surged to 10.2%, its highest level in more than 26 years, as employers cut more jobs in October.
::MYVOICEOFLIFE:: The U.S. economy grew at slower pace in the third quarter than initially reported as weak consumer spending and rising imports softened the effect of stimulus efforts. The revised numbers suggested that growth going forward would be slow.
The nation’s gross domestic product rose at an annual rate of 2.8 percent in the third quarter, compared with a contraction of 0.7% in the prior quarter, the Commerce Department reported Tuesday. The revised GDP falls short of the 3.5 percent originally estimated last month. Compared with a year ago, real GDP is down 2.5%.
Even though growth was slower, the third quarter probably marked the end of the longest recession since World War II, with the economy expanding for the first time in a year. The report does not mark the official end of the recession, though. That determination will be made by the National Bureau of Economic Research, likely sometime in 2010 once all the various economic readings have had their final revisions.
Much of the growth can be attributed to the billions of dollars the federal government has pumped into the economy as it seeks to mitigate the effects of a deep recession. But the nation is still grappling with the highest unemployment rate in 26 years, hampering efforts to persuade consumers to open their wallets again.
Consumer spending in the third quarter increased 2.9 percent, falling short of the 3.4 percent it reported last month. Economists said it was below healthy margins and lower than the levels seen in 1983, when unemployment was equally high. Consumer spending makes up about 70 percent of the economy. Households continue to struggle with damage balance sheets and lingering labor market weakness.
::SMARTINMONEY:: The U.S. government-administered insurance fund that protects depositors slipped into the red after fifty banks collapsed during the third quarter. The fund that protects more than $4.5 trillion of U.S. bank deposits fell into the red for the first time since the fallout from the savings-and-loan crisis of the early 1990s as the pace of bank failures accelerated.
The fund had a negative balance of $8.2 billion at the end of September after the fund dropped by $18.6 billion during the third quarter of 2009, federal regulators said Tuesday, Nov. 24. This report confirms what officials of the Federal Insurance Deposit Corporation (F.D.I.C.) said in October that the deposit insurance fund had been depleted.
The bulk of the fund’s losses were stemmed from $21.7 billion in provisions that regulators set aside to cover future failures.
Federal officials have taken action to replenish the fund. The agency recently approved plans calling for industry to lend money to the insurance fund by ordering banks to prepay annual assessments that would otherwise have been due through 2012. That move is expected to add about $45 billion to the fund.
The number of problem banks that run the biggest risk of collapse increased to 552, from 416 in the second quarter. F.D.I.C. officials expect that bank failures will cost the insurance fund $100 billion over the next five years. More than half of that cost has already been accounted for, while the new prepayment plan is expected to cover the rest. If losses grew considerably worse, officials might have to impose additional special assessments on banks or draw on the Treasury’s backup credit lines.
So far, the F.D.I.C. has seized and sold 124 banks in 2009, and analysts expect hundreds more to collapse in the months ahead. That has put significant pressure on the F.D.I.C. fund, which posted a negative balance for the first time since 1992 when regulators cleaned up the carnage from hundreds of failed thrifts and other commercial lenders.
The problems afflicting the bulk of the industry’s lenders, soured loans made to consumers and property developers, have grown considerably worse. Bad loans of virtually every stripe, credit cards, mortgages, small business and commercial real estate, continue to grow, albeit at a slower pace. Over all, banks charged off $50.8 billion in the third quarter, or 2.71 percent of assets. That is the highest charge-off rate in any quarter since the government began collecting data in 1984.
Despite the turmoil in the industry, banks posted a modest $2.8 billion profit in the third quarter of 2009, as their securities portfolios recovered and banks with less than $10 billion in assets saw margins improve. Bank profits were more than triple the $879 million they earned in the third quarter of 2008 and improved from a $4.3 billion loss in the second quarter of 2009.
Loan balances plummeted by $210.4 billion, or 2.8%, the largest percentage drop on record as banks pulled back credit and saw reduced loan demand. Balances declined across all major loan categories, with commercial and industrial loans falling by $89.1 billion, or 6.5%.
::MYVOICEOFLIFE:: More homeowners than ever are having trouble making their monthly mortgage payments, according to figures released Thursday. The figures underlined the level of stress on a large segment of the country, a situation that could put out the modest recovery in home prices over the last few months and impede any economic rebound.
The overall third-quarter delinquency rate is the highest since the association began keeping records in 1972. Nearly one in 10 homeowners with mortgages was at least one payment behind in the third quarter, the Mortgage Bankers Association said in its survey. It is up from about one in 14 mortgage holders in the third quarter of 2008.
The combined percentage of those in foreclosure as well as delinquent homeowners is 14.41 percent, or about one in seven mortgage holders. Mortgages with problems are concentrated in four states: California, Florida, Arizona and Nevada.
In the first stage of the housing collapse, defaults and foreclosures were driven by subprime loans. As the subprime tide recedes, high-quality prime loans with fixed rates make up the largest share of new foreclosures. A third of the new foreclosures begun in the third quarter were this type of loan, traditionally considered the safest. Without jobs, borrowers usually cannot pay their mortgages.
In previous recessions, homeowners who lost their jobs could sell the house and move somewhere with better prospects, or at least a cheaper cost of living. This time around, many of the unemployed are finding that the value of their property is less than they owe.
::MYVOICEOFLIFE:: More homeowners than ever are having trouble making their monthly mortgage payments, according to figures released Thursday. The figures underlined the level of stress on a large segment of the country, a situation that could put out the modest recovery in home prices over the last few months and impede any economic rebound.
The overall third-quarter delinquency rate is the highest since the association began keeping records in 1972. Nearly one in 10 homeowners with mortgages was at least one payment behind in the third quarter, the Mortgage Bankers Association said in its survey. It is up from about one in 14 mortgage holders in the third quarter of 2008.
The combined percentage of those in foreclosure as well as delinquent homeowners is 14.41 percent, or about one in seven mortgage holders. Mortgages with problems are concentrated in four states: California, Florida, Arizona and Nevada.
In the first stage of the housing collapse, defaults and foreclosures were driven by subprime loans. As the subprime tide recedes, high-quality prime loans with fixed rates make up the largest share of new foreclosures. A third of the new foreclosures begun in the third quarter were this type of loan, traditionally considered the safest. Without jobs, borrowers usually cannot pay their mortgages.
In previous recessions, homeowners who lost their jobs could sell the house and move somewhere with better prospects, or at least a cheaper cost of living. This time around, many of the unemployed are finding that the value of their property is less than they owe.
::SMARTINMONEY:: Investors around the world see the U.S. dollar as weaker than other currencies because of U.S. interest rates near zero and huge budget deficits. That prompts them to trade out of the dollar for riskier, high-yielding assets in equity markets and other countries.
The expectation that interest rates are set to remain low in the U.S. has been a key factor behind the weak dollar and buoyant commodity and stock markets. Investors are betting that policy makers will do little to undermine the strong support for stimulus policies that have done much to fuel global markets and restore risk appetite. They sold the American currency off earlier in the week by expectations that U.S. interest rates will be left low for some time. While the dollar may be gaining strength recently, concerns about the currency persist.
Federal Reserve Bank of Dallas President, Richard Fisher, said he is aware that the Fed's current stance of keeping interest rates low for an extended period was denting the dollar but that he didn't want to do anything about it, pointing out inflation is likely to remain subdued for some time. His comments echoed those of other Fed officials who indicated interest rates are likely to remain low.
On the other hand, Treasury Secretary Timothy Geithner, said Wednesday in Singapore that maintaining a strong dollar is very important for the country's economy and sustaining confidence in its financial system.
Soaring budget deficits, which hit a record $1.4 trillion in fiscal 2009, have also weakened the dollar. The U.S. has borrowed enormously to meet the U.S.'s day-to-day spending needs.
The dollar has declined 16 percent against a basket of six major currencies from the highs set in March and is down more than 37 percent from a peak in 2001.
Developing countries worry that the sinking U.S. currency is making their exports expensive and threatening their fledgling economic recoveries. A lower dollar and China's yuan, which is effectively pegged to the dollar, make other countries' goods relatively more expensive.
While speculation that the dollar is facing sustained devaluation cannot be ruled out, there are good reasons to expect a rally over the next nine to twelve months if the weak dollar helps the U.S. recovery picks up steam.
Positive commodity and stock markets
Investors are using weak dollar for what's known as carry trade. That means traders borrow cheaper dollars to make other investments such as in emerging-market currencies, oil or equities. Pressure on dollar can amplify as equity markets continue advancing and investors trade out of the currency for higher returns elsewhere.
The dollar tends to lose value as a result of government stimulus measures or better-than-expected economic reports as investors pursue riskier, high-yielding assets in other countries.
The APEC finance ministers at the 21-member Asia-Pacific Economic Cooperation summit in Singapore pledged to maintain government stimulus measures as long as the private sector remains weak. That will prompt a flood of money into developing countries. Many of these countries offer higher interest rates on their securities than the major economies do. But the resulting rise in the value of their currencies makes their exports more expensive.
The U.S. unemployment surged to hit its highest level in more than 26 years as employers cut more jobs in October. The myvoiceoflife.blog reported that the unemployment rate rose by 0.4 percentage point to 10.2%, a sign the labor market continues to struggle as the economy emerges from its deep recession. The unemployment rate of 10.2% was the highest since April 1983.
The economy lost another 190,000 in October, bringing to total number of jobs lost in the recession to 7.3 million.
Despite the apparent end of the Great Recession, economic expansion has yet to translate into jobs, leaving tens of millions of people still struggling.
The pace of job loss continued to taper off in October, the precursor to eventual growth. Amid the paralyzing fear between November 2008 and April 2009 the economy shed an average of 645,000 jobs a month. The pace dropped to an average monthly loss of 357,000 jobs between May and July. And over the last three reports, average monthly job losses have slipped to 188,000.
Some experts see that as the economy expands, companies will use fresh profits to add to payrolls as they reach for increased sales. As workers spend their paychecks, they will create opportunities for other businesses, generating more jobs. But some doubt whether recent trends of a 3.5 percent annualized rate economy grew can continue, absent another dose of government spending.
News that the nation's unemployment rate rose above 10 percent last month didn't derail the stock market's strong gains in the week, which lifted major indexes more than 3 percent. The bad economic news reassured some investors that the Federal Reserve will have to hold interest rates low for some time.
Low interest rates tend to weaken demand for the dollar, which in turn gives a boost to stocks. When the dollar is weaker, U.S. goods are cheaper for buyers overseas. Companies that do business overseas also get a profit gain when their earnings are translated back into dollars.
