Bottom-Fishers, Beware the Window Dressing

by Daniel Putnam | December 7, 2012 12:03 pm

It’s December, and that can only mean one thing. No, not mistletoe and yuletide merriment — this month, the real action involves year-end “window dressing.” This term refers to the tendency of portfolio managers to buy winning stocks to gussy up their 12/31 portfolio reports, while dumping losers to take tax losses and clear bad names of the books.

The concept of window dressing is so ingrained in conventional wisdom that it pays to take a closer look to see whether it actually holds up.

Based on the events of 2011, there is some validity to the notion.

A look at last year’s best and worst performers[1] in the S&P 500 Index reveals that there is a tendency for stocks to continue their previous trend through the final months of the year — although last year this was much more pronounced with the losers.

Among last year’s top 25 performers, 22 continued to trade through the end the year, while three were taken over prior to December. Of these 22, the average return in December 2011 was 1.72% — slightly ahead of the 1.05% return for the SPDR S&P 500 ETF (NYSE:SPY[2]). Fourteen of the 22 stocks outperformed, but several of the year’s winners gave up some of their gains in the final months, including Cabot Oil & Gas (NYSE:COG[3]), V.F. Corp. (NYSE:VFC[4]) and Estee-Lauder (NYSE:EL[5]).

As a result, investors might have eked out some extra return by prospecting for winners in this group, but overall, the positive aspect of window dressing didn’t have much of an impact.

The story was somewhat different among 2011’s worst performers.

Here, there was a pronounced tendency for the market’s weakest stocks to remain under pressure going into year-end. The average December return of the 25 worst performers was -6.69%, nearly 8 percentage points behind the broader market, and only six stocks in the group outpaced the S&P. Even if the two weakest stocks — Sears Holdings (NASDAQ:SHLD[6]) and First Solar (NASDAQ:FSLR[7]) — are thrown out of the mix, the average return for the group is still very poor at -3.93%.

Based on this small sample, the window-dressing effect indeed has an impact, but it’s more pronounced among underperformers. And the same thing could happen this year.

With the uncertainty associated with what 2013 tax policy is going to look like, investors have a significant incentive to book losses to help cushion the impact of higher taxes in the year ahead. So what stocks could be most vulnerable between now and year’s end?

Notable losers in 2012[8] include:

Other notable dogs include Best Buy (NYSE:BBY[14]), Radio Shack (NYSE:RSH[15]) and Dell (NASDAQ:DELL[16]), as well as just about any stock in the coal and gold mining sectors.

Trading stocks on this basis alone is obviously a dangerous proposition, especially at a time in which fluid headlines have the potential to push the market around on a day-to-day basis. Instead, the takeaway is that investors who are looking to bottom-fish in any of the year’s biggest losers might want to exercise patience.

They just might get a better price before the year is out.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

  1. last year’s best and worst performers:
  2. SPY:
  3. COG:
  4. VFC:
  5. EL:
  6. SHLD:
  7. FSLR:
  8. losers in 2012:
  9. APOL:
  10. AMD:
  11. CLF:
  12. JCP:
  13. HPQ:
  14. BBY:
  15. RSH:
  16. DELL:

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