"Don't step in front of a freight train." Sounds like good advice, huh? This investing axiom warns against trying to pinpoint tops and bottoms and fading strong moves. A recent article by one of Seeking Alpha's most outspoken authors prompted me to think of this axiom.
Paulo Santos just penned an article titled "Beware Of Research In Motion And Nokia Near Year-End." In it he espouses you should take profits on Nokia Corporation (NOK) and Research In Motion Limited (RIMM) prior to year end due to the fact that these names may experience outsized tax loss selling prior to year end, due to additional pressures mounted by the looming fiscal cliff, the fact they are down for the year and that they have substantial short positions.
Although I have much respect for Paulo's ability to spot a potential trading opportunity, I do not believe the risk is worth the reward in this case and I believe certain parts of his logic are flawed. In the following sections I will lay out my opposing case.
Key Points Where I Disagree With Paulo's Premise
The Risk Is Not Worth The Reward
Nokia and RIMM are two stocks that are very likely to get hit with tax selling near the end of 2012. As such, it might pay to anticipate such selling and sell into the present rally, even if one wants to stay in those two names. Then closer to 2012 year-end, the tax selling can be used to re-establish positions.
I believe the risk will not be worth the possible reward executing this short term trading strategy. Even if the stocks move according to Paulo's assertions, attempting to time the short window is not worth the time or trouble in my view. Besides, I don't see the stocks moving down based on tax loss selling in the first place. I will cover this point in detail in my next section.
Paulo has a penchant for suggesting highly speculative and risky trades that require perfect timing and swift action. In one of his initial articles published on Seeking Alpha, "Prepare To Buy Kodak", Paulo suggests buying Kodak (EKDKQ.PK) shares instantly after they declare bankruptcy. Paulo states:
But you will want to buy it (Kodak) as soon as they do go bankrupt! I mean in the first 30 minutes - 1 hour after they file bankruptcy, actually! We have a very rare, quite profitable, very risky, counter-intuitive trade coming up on Kodak. Be ready to take advantage of it, as the window of opportunity will be very narrow.
Please review Paulo's article for more details regarding this highly speculative and risky trade. I would never attempt this trade. The risk far outweighs the reward in my view. This is most likely the main reason why Paulo and I are at odds regarding his case for selling Nokia and RIMM and buying them back prior to year end. The risk vastly outweighs the reward.
The Looming Fiscal Cliff Will Exacerbate Tax Loss Selling
First, let me start out by saying I do not believe the Fiscal Cliff will occur. I posit U.S. politicians will resolve their issues in due course prior to year-end and the news of this will spark a Santa Claus rally into year-end negating some if not all of any tax loss selling effect.
But let's assume the looming fiscal cliff appears to be coming to fruition. I think Paulo's got the added effects of the event backwards. Paulo states:
In most years, tax selling is already a significant event, with investors selling some of their losers near the end of the year to offset the realized capital gains. This is also reinforced by the fact that the fiscal cliff might have led more investors to take profits during 2012 -- as opposed to 2013, where capital gains taxes might be much higher. This all means the effect could be even stronger. So widely held stocks that suffered losses during the year are bound to see more selling closer to year-end.
If investors believe that the capital gains tax will increase substantially next year, I agree with Paulo that increased profit taking on an investor's portfolio winners will occur. What I disagree with Paulo on is his statement that investors will also sell more than the usual amount of losers. I see investors holding back on selling their losers due to the fact that if capital gains do increase substantially next year they will get more bang for their buck next year rather than this year. So we are diametrically opposed on this point.
Nokia and RIMM are down for the year, yet there are many other stocks down much further with nowhere near the positive short term catalysts in front of them. Nokia's launch of their new phones has been a smash hit by all reports and RIMM's announcement of the Blackberry 10 has been long awaited and anticipated. I imagine there are better tax loss selling candidates in investors' portfolios than these two names for sure.
Moreover, the risk is simply not worth the reward regarding the trade. When you take into account the precise nature of this trade, it seems that all the stars must be aligned to make it work. Coincidentally, on December 21, 2012 all the stars and planets are supposedly going to be aligned, so maybe Paulo is right on this one, but I wouldn't gamble on it.
Additional disclosure: This is not an endorsement to buy or sell securities. Investing in securities carries with it very high risks. The information contained within this article for informational purposes only and is subject to change at any time. Do your own due diligence and consult with a licensed professional before making any investment decisions.