Stocks Under $10 Portfolio: Tax-Loss Selling Weighs on Indices

 | Oct 30, 2016 | 12:00 PM EDT
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The following is an excerpt from the Stocks Under $10 Weekly Roundup originally sent to Stocks Under $10 subscribers on Oct. 28. Click here to learn more about this dynamic portfolio managed by David Peltier.

U.S. stocks posted a 2% loss this week and we used the lower prices to add to our positions in Builders FirstSource  (BLDR) , Sonus Networks (SONS) and Teligent (TLGT) . Not even a better-than-expected initial report of 2.9% third-quarter GDP growth on Friday was enough to entice investors this week, which saw a slew of earnings reports.

So far this quarter, 71% of companies in the S&P 500 have exceeded earnings expectations, which is above the historical trend. 58% of the index has already announced results and aggregate earnings are up 2.61% year-over-year, which is the first increase since the second quarter of 2015. McKesson (MCK) , Sherwin-Williams (SHW) and Under Armour (UA) were some of the big names that posted double-digit declines this week, following disappointing earnings results.

On the other hand, Unilife (UNIS) was the big winner in the model portfolio this week, gaining 66%. The company announced the completion of an internal probe of the actions of former executives and found the firm suffered no financial loss. In addition, Unilife brought its regulatory financial filings back up to date.

One other likely reason for the decline this week was institutional tax-loss selling. This year marks the 30th anniversary of the Tax Reform Act, which sets Oct. 31 at the deadline for mutual funds to realize capital gains and losses each year.

As a result, losers from the first three quarters of the year tend to underperform again in October, which can create attractive buying opportunities. We believe this phenomenon is partly behind the recent declines in Builders FirstSource and TherapeuticsMD (TXMD) , ahead of the upcoming quarterly reports on next week. We will run a screen over the weekend to look for other potential victims of tax-loss selling in the universe of low-dollar stocks and report back to readers on Monday.

Looking ahead to next week, it will be busy on the economic front, including several regional business readings. We'll get a look at monthly vehicle sales on Tuesday, followed by the next FOMC interest rate decision on Wednesday. According to the CME Group, Fed funds futures are currently factoring in just a 9% chance of a rate hike next week, compared with a 78% probability by the meeting on Dec. 13-14.

It all leads up to the October jobs data next Friday, which will be the last material economic report ahead of the presidential election on Nov. 8. Economists are predicting the addition of 175,000 non-farm payrolls in the month, up 19,000 sequentially and including 165,000 jobs in the private sector. The headline unemployment rate is predicted to tick down to 4.9% and average hourly earnings are expected to increase 0.3% month-over-month.

Going into next week with four companies in the model portfolio expected to post quarterly results, we maintain an above-average 36% cash position. Whether it's because of tax-loss selling, the prospect of higher interest rates or a post-earnings decline, we're ready to put some of those funds to work as buying opportunities emerge.

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