The SPX’s decline of nearly 1% yesterday, the largest since December 11th, represents about a quarter of the 4% gains since the FOMC announced its plans to decrease the size of its bond buying program on December 18th. To put it another way, U.S. equities gave back a quarter of the late year window dressing that helps fund managers get closer to their benchmarks or maybe even beat them, and also helps them get paid!!! On December 17th in this space I mentioned the following:
we often hear the term window dressing where portfolio managers gun their biggest winners, or stocks that they know they can push around into the end of the year. Put quite simply, the higher a stock is at the end of a reporting period, the larger the return for the PM and the greater the potential for him/her to get paid! And who really cares if they end up getting too long into Dec 31st as they can just sell in the New Year that extra portion and they will have 51 weeks to make back that performance (assuming that it is even down as year end and new year are historically very strong periods for equities).
While that might have sounded a tad cynical, that is very much the mindset of many institutional portfolio managers, even though they won’t admit it, and yesterday’s price action is partially a by-product of that behavior.
There were likely other factors at play though in yesterday’s price action, as Enis astutely pointed out in his MacroWrap this morning:
tax considerations play a big role, especially after a large gain for the indices like what we saw in 2013. Rather than pay taxes on those capital gains in the 2013 cycle (so by April 15, 2014), investors hold on to stocks that they’re looking to sell until the calendar hits 2014. Once they sell in 2014, they won’t have to pay taxes on those gains until April 15, 2015. That is sometimes cited as a potential reason for weakness after a very strong year.
This could obviously be the reason for some of the selling but when you look at the performance of stocks like TWTR up 6%, Solar names (FSLR & SCTY both up 5%) and 3D printing stocks all up on the day, some of the speculative stocks from 2013 that had massive gains, investors clearly want to stick with what has worked, for now.
I guess the last point I would make is that taking too much away from a less than 1% decline in the SPX, after such a monster year would be fairly useless, and the next real barometer for U.S. stocks will be Q4 earnings that will start in earnest the week after next. I would also add that it would be complacent of investors not to keep an eye on the damage done in emerging markets the last couple days with Brazil and China down a bit more than 1.5% and the ETFs that track these markets (EEM, EWZ & FXI) all down more than 3% in yesterday’s trade. While China’s weak non-manufacturing PMI data will be cited (lowest reading since August), from where I am sitting EM and the potential for reflation of growth is the single largest risk to the rally in the developed world. While bulls point to the stabilization and the lack of hard landing, if we are to see a correction in 2014, a stagnation or a mild decline in growth would likely be the stumbling block.