As the holidays approach, it is important for investors to remember that while stock markets are liquid and efficient most of the time, there are still times when patterns, trends and unexplained phenomena affect equities.
With that in mind, investors should be careful when buying or selling stocks around the end of the year. According to Tim Courtney, chief investment officer of Exencial Wealth Advisors, investors should use the end of the year to look at their accounts and rebalance their portfolios.
“Reconfirm that your allocations are where they need to be and that nothing over the last year has changed that would cause you to change your strategy,” he said. He added that this year, many investors will probably find that their U.S. assets and growth assets have likely outperformed their international and value assets.
“If you have had changes, then I would start to work out a timeline right now for how long it’s going to take to get to the allocations that you need to be at,” he said. It is also wise to keep the following 10 rules in mind this holiday season:
1. Beware the ‘January Effect’
The so-called “January effect” is arguably the biggest unexplained phenomenon in stock market investing. Numerous studies by economists have shown that stocks tend to rise in value in January.
No one has ever been able to come up with a convincing reason why stocks on average do better in January — after all, if rational investors know that stocks will on average rise in January, shouldn’t they just buy in December in anticipation?
Regardless, investors should understand this effect and act accordingly. Investors considering dumping stocks in December might be better off waiting a few weeks and selling in January instead. While there are no guarantees of course, January has historically been a rewarding month for investors.
2. Avoid Making Big Trades Around ‘Window Dressing’ Time
Mutual funds and to a lesser extent hedge funds generally have two purposes: To maximize returns for a given level of risk, and to bring in more investor capital.
To accomplish the second goal, many funds engage in what is called “window dressing.” They tend to make big changes in their portfolios just before the end of the year in an effort to alter what investors see and make the fund look as attractive to new investors as possible.
As a result, the last week of December can often create a market where trading is largely disconnected from fundamentals and instead is driven by fund managers making trades related to window dressing. Given that, smart investors should mostly ignore any large moves in stocks and hold out until the new year starts before making big trades.
3. Don’t Short Stocks Around Fed Announcements
The Federal Reserve’s Federal Open Market Committee sets the nation’s monetary policy. It meets eight times at approximately six-week intervals throughout the year. Every time members of the FOMC get together, it creates moments of anxiety and excitement throughout the market.
Studies have shown that on average, stocks move higher in the periods surrounding Fed meetings and the associated announcements that follow the meetings. This might be because investors like to see that the Fed has a good handle on what is going on in the economy, or that the markets just respond positively to greater certainty after a Fed meeting ends.
Either way, it’s generally a bad idea to short stocks going into a Fed meeting. The next meeting is scheduled for Dec. 15-16.
4. Retailers Can Create Holiday Magic
Retailers do an outsized level of their sales during the fourth quarter, and around the holidays in particular. Holiday sales are critical to many stocks, especially retailers. No company is immune, as giant retailer Walmart discovered recently when its stock plunged after the CEO made less than cheery comments regarding sales and profit numbers for the coming quarter.
Conversely, companies that do well over the holidays can see their stocks fly higher.
5. The Holidays Can Make or Break Some Companies
Related to item No. 4, some companies can see outsized volatility in their stocks related to the holiday season. Firms like Hasbro and Mattel, for instance, rely on holiday interest in their toys to generate sales over the following year.
For that reason, investors should investigate any big product announcements by firms in the period leading up to the holidays. Google Trends can be an invaluable tool to aid you in researching. Smart investors can use trends in Web searches to predict interest by consumers in various companies and products. Studies have shown such interest to be correlated to future stock prices.
6. Expect Low Volumes Around the Holidays and Act Accordingly
Many traders and finance professionals take time off around the holiday, so trading volumes tend to be lower on average at some points in the holiday season, especially around Christmas. For that reason, investors should avoid making any major trades in stocks with low levels of liquidity.
When investors buy or sell stocks and the liquidity is not there to absorb the trade, the price can move against the buyer, creating an unobserved cost. Smart investors avoid creating larger liquidity costs for themselves than necessary.
7. Black Friday Success Can Be Crucial
Analysts say that as we move toward Thanksgiving, the stocks of some retailers might be good investments. Retail stocks often move higher in the run-up to Thanksgiving. However, those stocks might fall after that if Black Friday results are less than stellar.
Ecommerce trends are particularly important to many retailers this year, and smart holiday investors should pay attention to which companies have a strong unified set of product offerings both in-store and online.
8. Pay Attention to International Events
Perhaps the biggest surprise for investors around the 2014 holidays was the bombshell OPEC dropped on the markets when it declined to cut oil production. That caused oil prices to crash below $70. The action set the stage for significant stock market declines across the energy sector and led to further falls in oil prices through December and much of January.
That event is a stark reminder to investors that while U.S. consumers might put on their blinders around the holidays, smart investors need to remain alert to what is going on around the world. OPEC meetings, Chinese economic data and the ongoing European financial saga all promise to be major events during the fourth quarter.
Sage investors will devote a little of their holiday free time to thinking about these events and how the outcome might impact their portfolios.
9. Consider Tax Consequences for Your Portfolio
Much like the Grinch, the IRS has little interest in Christmas. Instead of seeing December as a time for celebrating, America’s most loathed government agency is mainly concerned with the investment choices Americans make in the days leading up to New Year’s.
Smart investors must make sure they are taking steps to manage their tax burden for the new year by deciding which stocks to sell and which ones to hold. Tax strategy is complex of course, and it’s certainly worth talking to an accountant. But investors need to decide ultimately if they want to cash out gains or losses on any given stock, and recognize that gain or loss in 2015 or hold on until 2016.
For stocks held longer than one year, gains or losses will be classified as long term and more favorably taxed. By contrast, stocks held for less than one year will have short-term gains and losses, and will be taxed less favorably.
10. Decide on Financial Moves Ahead of Time
Many financial professionals go on vacation around the holidays, and this can create problems for investors. Reaching your broker or just placing a trade can be harder in December, especially as people take days off from work and exchanges move to holiday hours.
Throw in the phenomenon of triple witching — when contracts for stock index futures, stock index options and stock options all expire on the same day — and the confusion that surrounds different trading hours for different types of financial products, and you have a recipe for serious headaches for investors trying to make last-minute decisions. With that in mind, it’s usually wise to have a financial game plan ahead of time and stick to it when it comes to holiday investing.
While the holidays can be personally rewarding for many people, they can also be a challenging time for investors. Following these 10 holiday trading rules will result in a happier and hopefully more profitable trading season for everyone.