Silver linings, lemonade, and the glass is half full

Avatar photo by Hiren B. Patel, Head of Advisor Solutions

Tax-loss harvesting gives us some reason for optimism in down markets

Key Takeaways

  • Returns and valuations in today’s market downturn are far from uniform.
  • Volatile markets are creating continuous opportunities for tax-loss harvesting.
  • Direct indexing and improved technology now make these opportunities easily accessible.

It’s been an especially turbulent year for stocks – and bonds. The S&P finished the third quarter down 24.8% for the year. In stark contrast, the growth of direct indexing continues unabated. The “direct” ownership of the shares that comprise an index is estimated to grow at 12% per year1, faster than mutual funds and ETFs – and for good reason. Owning stocks through broad mutual funds and ETFs doesn’t create opportunities to reap the possible tax benefits within the overall market, direct indexing solves for that.


Facing rising rates and inflation, earnings worries and recession fears, and the breakdown of stock-bond correlations, investors and advisors alike would be forgiven for thinking the glass is nowhere near half full. Still, volatile markets, unpleasant as they may be, are providing more than the usual opportunities for tax-loss harvesting.


It’s critical though to be able to access these opportunities at the security level and with more frequency than has typically been the case. Today, using tax-loss harvesting with a direct-index strategy makes it possible to find silver linings in some very dark clouds.

Wide Variances in Stock Returns Today

While it may seem like all stocks are experiencing similarly poor performance during a steep market decline, the valuation dispersion within the S&P 500 Stock Index demonstrates that is not the case. This year, as the chart below shows, the dispersion between the S&P 500 stocks that are in the 80th percentile for price/earnings ratios and those in the 20th percentile exceeds what it has been for the past 25 years.

Current Valuation Spreads of Large-Cap Stocks Exceed the 25-year Average

Valuation dispersion between the 20th and 80th percentile of S&P 500 stocks
Valuation dispersion between the 20th and 80th percentile of S&P 500 stocks

Considerable Disparities at the Sector and Security Levels

The varied opportunities become even more apparent when you consider the year-to-date returns at the sector level and across individual securities.

  • The Communication Services sector was down 39.4% through the first three quarters of 2022.
  • Information Technology declined 31.9%.
  • The Consumer Discretionary sector dropped 30.3%.
  • The Energy sector, however, has had a banner year, and was up 30.7% through September 30.2

Many energy stocks have posted spectacular individual returns.

  • Occidental Petroleum was up 112% through the end of September.
  • Constellation Energy’s stock price increased by 76.5%.3

While the S&P 500 Index has declined by 23.9% through the first nine months of 2022, many stocks are down by much more.4

  • Carnival Corp. dropped by 73.5% through September 30.
  • Caesars Entertainment declined by 73.1%.
  • Dish Network was down 70.1%.5

Granted, these numbers are changing markedly on a daily basis, but that’s now a reason for a little optimism.

Automate the Opportunities

Today it’s possible to access these security-level opportunities with increased frequency and ease, whether through direct indexing or actively managed SMAs. While many advisors rely on a manual process at year-end to identify tax-loss harvesting possibilities for clients, 55ip’s ActiveTaxSM technology enables advisors to automate this process. It reviews the potential for tax-loss harvesting in client portfolios on a monthly basis, so that any intra-year dislocations in stock prices’ can be identified and acted on.

Contact 55ip to learn how we can support your efforts to make a down year more palatable for clients who can take advantage of tax-loss harvesting.

Footnotes

1 “Direct Indexing Growth Projected to Outpace ETFs, Mutual Funds, and Separate Accounts ,” Cerulli Associates, 8/16/21

2 “These 20 stocks in the S&P 500 tumbled between 20% and 30% in September,” MarketWatch, through 9/30/22

3 “Best-performing stocks: October 2022,” Bankrate.com, as of 9/30/22

4 ”Why it’s smart to keep investing during a ‘garden variety’ bear market,” CNBC.com, 10/4/22

5 “These 20 stocks in the S&P 500 tumbled between 20% and 30% in September,” MarketWatch, updated 10/3/22

Past performance does not guarantee or indicate future results and there can be no assurance that any investor will achieve comparable results or that any return objectives will be met. No representation is made that any investor will, or is likely to, achieve results comparable to those shown. All investments involve risk, including loss of principal. 

The impact of a tax-loss harvesting strategy depends upon a variety of conditions, including the actual gains and losses incurred on holdings and future tax rates. The results shown in these materials are illustrative and do not represent actual investment decisions.

The tax-loss harvesting service is available for an additional advisory fee and the results shown represent the net effect of the advisory fees but may not consider the impact of fees charged by others, including transaction costs or other brokerage fees. The information contained herein is subject to change without notice, is not complete and does not contain certain material information about the investment strategy, including additional important disclosures and risk factors associated with such investment and information about fees, trading costs and taxes. Neither the U.S. Securities and Exchange Commission nor any state securities administrator has approved or disapproved, passed on, or endorsed, the merits of this document. More information at www.55-ip.com.

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