Tax Effects on Markets

cropped-bob-shapiro.jpg   By Bob Shapiro

Many factors affect the ups and downs of markets, including Taxes.

Let’s look at how Capital Gains Taxes exert their influence, especially at year end.

There are two kinds of investors:

  • Those who think a particular investment will go up, and
  • Those who think a particular investment will go down.

All of these investors have various ways to place their bets on what they expect the future to bring. For stock market Bulls, they may buy the underlying stock, they may buy call options, or they may sell put options. For Tax purposes, the effects are close enough that I will consider them the same.

Bears have the same selections as are available to Bulls, just in reverse. For example, they may short sell a stock.

For any stock, some investers are Bullish while others are Bearish. So, while some buy stocks long, others sell the same stock short.

For any stock, the results are either the stock goes up, goes down, or stays the same. (Yes, it really does break down this simply.) Here it is in graphical format (excluding unchanged investments).

bulls-v-bears

So, now we come to the end of the tax year, and we have to decide whether or not to close out the position. For the Bull who has profitted, if he sells the stock, he must pay a Capital Gains Tax this year.

If he waits until after the New Year to sell, he still pays the Capital Gains Tax, but that is on next year’s taxes. And next year (as President-Elect Trump has said), the rate may be different (lower).

The Bull with a profit has an incentive to wait before selling. With (marginally) fewer sell orders, the price of the stock has something of an up bias until the end of the year. And, the stock has a down bias right after the tax year ends, as those who waited to sell then do so.

The Bull with a loss has the opposite bias (to sell before the tax year ends). This way he locks in the Capital Loss against this year’s other earnings.

Image result for bull bear images stock market

The Bear investor who profited as the stock went down has a similar situation to the Bull whose stock went up, but it is to his advantage to not buy the stock to close his position. The (marginal) decrease of buying would reinforce the trend (in this case toward the downside).

The Bear with a loss case is similar to the Bull with a loss, and has an incentive to close out the losing investment.

The bottom line is that, at year end, investments which have shown a profit have a bias to continue the trend (either to continue going up or continue going down), while stocks which have shown a loss will have a bias also to reinforce the trend.

spx-122816

We can see this with the S&P500 stock index, which by several measures has reached into Bubble Levels, the up trend has continued for November & December (and now is resisting the popping of the Bubble).

And, we can see this also in an investment which has been going down since midyear – the Gold market. As Gold has gone down, the bias against Profit Taking likely has added to the down trend.

gold-122816

But, keep in mind that a bias before year end to reinforce the trend ends with the new year. I would expect that the S&P500 would move down starting early in January, while Gold likely will move up.

There are many more influences on investments, such as a stock’s PE levels (currently Bubble Level) and a new Presidential office holder. So, while I would expect a lower stock market and a higher Gold price in January, we’ll have to wait a little to see what actually happens.

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