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Morgan Stanley: Tax-Loss Harvesting Boon Coming

By Murray Coleman October 11, 2017

The after-effects of hurricanes and relatively high hurdles set in past quarters are causing many Wall Street brokerages to lower their earnings projections for third-quarter results. But analysts at Morgan Stanley are warning advisors and their clients that consensus estimates might be too low.

And that could prove to be a boon for year-end opportunities to tax-loss harvest, according to the wirehouse’s equity strategist Michael Wilson. In a note sent earlier this week, his team observes that “stocks correctly recognized this low bar a few weeks ago and have rallied sharply” to create a mix of winners and losers in this year’s calendar closing.

“We would expect to see a pull back or consolidation as earnings are actually reported — i.e., a sell the news event — before it can make its next surge,” Wilson says in reference to the blue-chip S&P 500 index.

The Morgan Stanley researchers have put together a list of 62 stocks in the S&P 1500 index they consider ripe for TLH. Such a practice lets advisors sell underwater stocks and funds and then repurchase those same securities 31 days later. Those temporary losses can then be booked in most cases against clients’ investment gains for tax purposes.

In the report, Wilson also points out “individual losses are of course determined by holding period.” But in his analysis, screening market results on a stock-by-stock basis can uncover “at least” a 10% drop in value in many shares since early this year.

Consumer discretionary, energy, industrials and even some large-cap tech stocks are represented in the Morgan Stanley screens. Long-term results suggest names which are sinking at this point in the year will keep falling into the fourth quarter, Wilson finds in his data crunching. Activity surrounding harvesting those dips will add even more pressure, he predicts.

Steve Braverman

By contrast, his team believes third-quarter S&P 500 consensus forecasts of 2.6% earnings growth will turn out too low for most other stocks. Such a view is in keeping with prevailing sentiment among major U.S. brokerages that clients face a better stock picking environment for active managers as markets diverge.

Steve Braverman, an advisor at Pathstone Federal Street in Fort Lee, N.J., also sees volatility picking up in the fourth quarter. “Up to this point, in many areas, the market volatility has been running at its lowest levels in decades,” says the co-CEO of the independent RIA, which manages about $12 billion.

Besides volatility moving back to more normal levels, Braverman also finds broad domestic stock benchmarks trading at “bearishly high” market valuations. “So we think it’s very possible that by year’s end new tax-loss harvesting opportunities will present themselves,” he says.

But at Pathstone, he notes, the “vast majority” of client assets include sizeable portions in taxable accounts. That makes TLH a “year-round” activity, Braverman adds. The RIA uses proprietary software to identify taxable trades that can benefit investors.

“Our system is checking daily market movements as well as activities within each family’s overall balance sheet that can create tax friction,” Braverman says.

Still, he cautions that with stocks marking new highs throughout the year, finding losers isn’t as easy a process these days. “The old-fashioned way of hunting and pecking through portfolios is going to be very inefficient and highly challenging in coming months,” Braverman says. “Successful harvesting in this type of environment needs to be uniquely and innovatively managed and executed.”

Andy Kapyrin, an advisor at RegentAtlantic in Morristown, N.J., is taking a wait-and-see approach. The chief investment officer at the indie RIA, which manages more than $3.5 billion, tells clients that such harvesting moves are part of his firm’s strategic oversight of their wealth.

“For the most part, stocks have done well so far this year,” Kapyrin says. “Harvesting any positions that we haven’t already addressed at this point is purely speculative and represents an effort to time markets.”

The idea of chasing downward momentum, he adds, can lead to substantial changes in a client’s asset allocation plan. Key to sticking to someone’s longer-term portfolio goals, Kapyrin observes, is making sure to find proper substitutes for stocks sold temporarily to book losses.

“You don’t want to let the tax tail wag the dog,” he says. “That’s the danger of trying to get too proactive with tax-loss harvesting — you can focus too much on selling and not enough on what you need to buy in the meantime to replace any lost exposure to major parts of the market.”