To pick 2023’s winners, look to 2022’s losers
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That’s because such stocks typically bounce back in a big way. But it will take courage to even consider buying them: The 10% of stocks within the S&P 1500 with the worst 2022 performance lost an average of 62.6%–more than three times the 19.1% loss for the index itself.
It can seem counterintuitive that a given year’s worst performers often become the subsequent year’s winners. But it makes sense, according to contrarians: Investors tend to overreact, propelling losing stocks to lose even more than is justified by their fundamentals. This sets up the preconditions for a significant rebound.
There is a non-contrarian reason as well: tax-loss selling at the end of the calendar year will be concentrated in stocks that have already lost the most, since they will be the ones whose sales allow taxpayers to shelter the greatest amount of capital gains and thereby avoid tax. That causes such stocks to be depressed even more than they would be any way. Once the artificial selling pressure created by tax-loss selling abates, these stocks typically rebound.
A classic illustration of this rebound effect was the terrible performance of oil and gas stocks in 2020 and their stunning bounce back in 2021. The Energy Select Sector SPDR lagged behind the S&P 500 by 49 percentage points in 2020, and then beat the benchmark by 26 percentage points in 2021.
Another recent example traces to the stocks that make up with so-called “Dogs of the Dow,” which is a portfolio that, at the beginning of each calendar year, invests in the 10 stocks from the Dow 30 with the highest dividend yields. These 10 typically are among the prior year’s worst performers.
Though the Dow Dogs don’t always beat the market, on average over the long term they have done so. 2022 was one such year. Take the 10 highest-yielding Dow stocks at the beginning of last year. In the prior calendar year—2021—these 10 as a group lagged behind the Dow Jones Industrial Average by 6.4 percentage points. In 2022, in contrast, they on average beat the DJIA by 10.9 percentage points.
Avoiding value traps
It’s important to stress that not all big losers from a given year beat the market in the subsequent year, however. Sometimes there will be good reasons why a given year’s worst performers will have lost as much as they did—and are therefore likely to continuing losing in subsequent years as well. If you buy such stocks you run the risk falling into what’s known as a “value trap.”
That’s because such stocks typically bounce back in a big way. But it will take courage to even consider buying them: The 10% of stocks within the S&P 1500 with the worst 2022 performance lost an average of 62.6%–more than three times the 19.1% loss for the index itself.
It can seem counterintuitive that a given year’s worst performers often become the subsequent year’s winners. But it makes sense, according to contrarians: Investors tend to overreact, propelling losing stocks to lose even more than is justified by their fundamentals. This sets up the preconditions for a significant rebound.
There is a non-contrarian reason as well: tax-loss selling at the end of the calendar year will be concentrated in stocks that have already lost the most, since they will be the ones whose sales allow taxpayers to shelter the greatest amount of capital gains and thereby avoid tax. That causes such stocks to be depressed even more than they would be any way. Once the artificial selling pressure created by tax-loss selling abates, these stocks typically rebound.
A classic illustration of this rebound effect was the terrible performance of oil and gas stocks in 2020 and their stunning bounce back in 2021. The Energy Select Sector SPDR lagged behind the S&P 500 by 49 percentage points in 2020, and then beat the benchmark by 26 percentage points in 2021.
Another recent example traces to the stocks that make up with so-called “Dogs of the Dow,” which is a portfolio that, at the beginning of each calendar year, invests in the 10 stocks from the Dow 30 with the highest dividend yields. These 10 typically are among the prior year’s worst performers.
Though the Dow Dogs don’t always beat the market, on average over the long term they have done so. 2022 was one such year. Take the 10 highest-yielding Dow stocks at the beginning of last year. In the prior calendar year—2021—these 10 as a group lagged behind the Dow Jones Industrial Average by 6.4 percentage points. In 2022, in contrast, they on average beat the DJIA by 10.9 percentage points.
Avoiding value traps
It’s important to stress that not all big losers from a given year beat the market in the subsequent year, however. Sometimes there will be good reasons why a given year’s worst performers will have lost as much as they did—and are therefore likely to continuing losing in subsequent years as well. If you buy such stocks you run the risk falling into what’s known as a “value trap.”
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