Midyear Review Of 2016's Year-End Bounce Portfolio

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Includes: CMG, COTY, CVS, EQR, FEYE, FIT, FSLR, FTR, GPRO, TRIP, TWTR, WTW
by: GreatQuarter

Summary

Tax loss selling and portfolio window dressing can artificially depress underperforming stocks in the final trading days of the calendar year.

Our 2016 year-end bounce portfolio, published on Seeking Alpha on the last trading day of 2016, outperformed during January by more than five percentage points, the stated goal.

Two charts showing year-end bounce portfolio relative performance, which we have not seen elsewhere, can be found below.

A calculation of beta supports the contention that the primary driver for the success of this strategy is simply the bounce back following the December sell-off.

With the benefit of six months of trading in 2017, this article reviews our Dec. 30, 2016, Instablog "Attention Nimble Bargain Hunters: A Year-End List Of Bounce Candidates Expected To Outperform In January" and follow-up comments in January that time-stamped the exit on Jan. 10th and Jan. 19th.

Theory Behind the Year-End Bounce Strategy

Toward the end of the calendar year, artificial selling can cause mispricings in stocks. Some non-economic sellers are individuals who are locking in losses for personal tax purposes. Others are institutional investors who aren't eager to explain to paying clients why they were invested in losers. In certain stocks, this non-economic selling depresses prices into year-end. These artificially depressed stocks could bounce in the new year, providing nimble bargain hunters with an opportunity to profit.

The best bounce candidates are usually those stocks that have declined the most, often due to investor dismay at real problems at the company. It is difficult to sort out which risky, underperforming companies will perform well in January. Many will temporarily bounce and then resume their earlier decline. Others could turn around and become good performers in the new year. Buying a basket is the optimal way to execute this strategy.

A good bounce candidate will meet most of the following criteria:

  1. Bottom 10% of S&P 500 performers for the calendar year
  2. Declining stock price into late December
  3. Manageable perceived headline risk
  4. Insider buying
  5. Bearish sentiment (although many studies show that heavily shorted stocks really do underperform the market)

While some in the year-end bounce portfolio basket will turn out to be bad performers, the expectation is that the basket as a whole will outperform the S&P 500 during January, hopefully by five percentage points. But there are risks. The plan is to exit the trade in January.

Review of the Bounce Portfolio's Performance Over the Past Six Months

As shown in the chart below, the bounce portfolio did achieve our late-December stated goal by outperforming the S&P 500 in January by five percentage points. (The portfolio outperformed by 538 basis points on the Jan. 17th close, although GreatQuarter averaged 366-basis-point outperformance in time-stamped exits via Jan. 10th and Jan. 19th Seeking Alpha comments.) Impressively, on a year-to-date basis, the bounce portfolio outperformed the S&P 500 every day in January.

On Feb. 3rd, the year-end bounce portfolio's year-to-date relative performance turned negative, culminating in a 10-percentage-point relative decline in March. Ouch! That severe underperformance underscores the plan to exit the trade in the month of January. Many of the worst-performing stocks at the end of a calendar year really do deserve to underperform, even if the underperformance is exaggerated at year-end and a bounce might be warranted early in the new year.

Underscoring the power of the bounce, during the first half of 2017 there were three days when 11 of 12 components outperformed the S&P 500, all in the first half of January: Jan. 5th, 6th, and 13th. (There was never a day when all 12 outperformed on the same day.) Similarly, in the first half of 2017, there were three days when only one of the 12 components outperformed the S&P, all in March: March 15th, 16th, and 20th.

For two portfolio stocks, the low price in January was also the low price for the first half of 2017. For four stocks, the high price in January represented the high price for the first half of 2017.

The median multiyear beta of the components of the bounce portfolio is 0.67, indicating that the bounce portfolio is less volatile than the market on a multiyear basis.

While rarely calculated, the median one-month beta of components for January 2017 was 0.09 (our calculation). A beta of 0.09 -- meaning a 1.0% rise in the market led to a 0.09% rise in the median stock -- suggests that the bounce portfolio did not meaningfully benefit from the typical January stock market strength. For January, four component stocks had negative betas. The bounce portfolio bounced largely on its own, with minimal general market assistance.

Charts of the 12 components of the 2016 year-end bounce portfolio, along with the S&P 500 index, can be found below. January trading is circled in red.

Next Update for This Year-End Bounce Portfolio Strategy

On Friday, Dec. 29th, 2017, I plan to publish a new year-end bounce portfolio for the anticipated January 2018 bounce.

Disclosure: I am/we are long CMG, COTY, CVS, EQR, FEYE, FIT, FSLR, FTR, GPRO, TRIP, TWTR, WTW.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.