One Possible Explanation for the January Stock-Market Fall

In a Wall Street Journal op-ed, Red Jahncke argues that the recent drop in U.S. stock markets may be a delayed response to a tax change:

In late 2012, investors sold huge amounts of investments with long-term capital gains to take advantage of the expiring 15% “Bush” long-term capital-gains tax rate before the current 23.8% rate for higher-income investors took effect on Jan. 1, 2013. These sales left investors with few unrealized long-term gains going into 2013.

Instead, as the market surged, investors’ new gains were held mostly in short-term positions, which they were loath to sell given that short-term gains are taxed at ordinary income-tax rates (39.6% for high earners). With this inhibition there was less sales pressure last year, and for that reason the market may have risen more than it would have otherwise. Indeed, last year’s 30% market gain exceeded most analysts’ predictions.

This year may be different, with more stocks purchased in 2013 reaching a one-year holding period. With the gains now taxable at lower, long-term rates, investors will be less inhibited about selling when they get nervous. That’s what happened last month. The result? A rush to sell and the Dow’s worst January since 2009. These sales may have been fueled by stock purchased 12 months ago with the proceeds of the huge volume of last-minute sales in December 2012.

Jahncke is careful to say that proof of this argument is scant, but you can see why the theory is appealing. This of course wouldn’t explain steeper drops in other countries unless you believe the U.S. is (still?) the dog that wags everyone else’s tail.

Steve Cebalt

This strikes me as really insightful. These vast differences in tax rates could have far deeper consequences on savvy investors' net returns than many other variables that are easier for the business media to write about by cherry-picking headlines and confusing correlation with cause and effect.

That's my peeve with the business media. Every day in virtually every media outlet, reporters ascribe causative powers to a headline of the day, and say, with no evidence, that the market rose or fell accordingly. For example: "Stocks soared today as investors cheered a jobs report that showed stronger-than-expected non-farm payroll in December." Just because that report came out on the same day that stocks rose, does not mean that the report CAUSED stocks to rise. But you see it every single day. Drives me nuts.

Larsen Conrad

This was an absurd piece, even by the standards of the WSJ editorial page, which will accept weak statistical links as long as they are used to support the right arguments. Barron's has a smart takedown here:
Among the many logical fallacies, Jahncke assumes that the same investors who rushed to sell their stocks in order to pay the lower 15% tax rate then rushed to sell again in order to get hit with the higher tax rate that they were so eager to avoid in 2012. Of course the fact that taxable U.S. investors are only a small part of the global markets is a rather important and ignored point.
And those of Mr. Jahncke's political persuasion have been telling us that the bull market was simply an artificial product of easy money (and that may very well be correct) .... so, perhaps the tapering of easy money might be at play here?
But perhaps nowhere is Mr. Jahncke's cluelessness more neatly revealed than with this line: "Indeed, last year's 30% market gain exceeded most analysts' predictions." Never, in the history of markets, have "analysts' predictions" ever been correct. And yet he uses that fact as evidence to support a complicated theory which, he admits, there "is scant data to confirm." Perhaps the new CEO of Dow Jones will hold the op-ed page to higher standards.


steve cebalt

Hi Larsen:

Jahncke's thesis is actually not a complicated theory as you say, nor is it fallacious, for his thesis is simply that among all the other factors affecting the US markets -- tapering, emerging market volatility, etc., there is also a US-specific tax effect that may affect decisions on US investments. He does not say nor suggest that this is the only factor that will drive the US markets, only that the effects of US tax changes since 2012 will add to volatility among certain US investors this year. I find that easy to understand, but no one else has been talking about it, so he should get credit for pointing it out.

Larsen Conrad

By "complicated" I didn't mean that it was hard to understand. I meant that in order for his thesis to hold up, you must believe that tax law incentivized not one, not two, but three separate actions by investors. First they had to sell in 2012 to beat the new law. Okay, I buy that to a certain extent. Then, they had to buy again in January, 2013. And again, I buy that to a certain extent, but you'd lose some investors to friction -- either they would delay for a few weeks or months, or they would not reinvest, or they would chose different, tax-advantaged investments (remember, they must be tax sensitive), or mutual funds, etc. Third, they had to sell those investments as soon as 12 months had passed. This is the particularly thorny part: Why would investors who have been motivated by a desire to avoid a 23.9% tax take the earliest possible opportunity to get hit by it? Jahnke seems to hint that they got "nervous," presumably by the falling market. But if the falling market was allegedly caused by this tax-motivated selling, then his argument is circular. And yes, 23.9% beats 39.4%, but that spread between short and long-term gains hasn't changed much, so that is not a factor.
Importantly, this is but one small hole in his argument; there are plenty of others related to the fact that U.S.-based taxable investment accounts are a quite small share of the money moving in and out of the market.


steve cebalt

Hi Larsen: That's an excellent analysis -- thanks for taking the time to walk me through your reasoning a second time. It makes a lot of sense. I think some of your strident language had me put up my blinders the first time :) I shouldn't do that to myself, because, like you, I have strong views, and I enjoy expressing them strongly! Cheers.

Larsen Conrad

We just made internet history: A pleasant exchange in the comments section. I don't think this has ever been done. Thank you!


Another explanation is the manipulation of financial and equities markets.
See - Gold Wars: Battle for the Global Economy on Amazon. Pretty cool equation for this phenomenon.


Anyone who thinks that investing Long-term in the Stock Market should watch the performance of the Nikkei since about 1989 and look at other demographic and economic similarities between Japan then and the US now.


So I have to ask the Buffet question, would investors really get out of stocks when there is actually NO WHERE ELSE to make the gains available in the stock market. What a new Money Market. Oh, I know, CD's! Real Estate. HOLD IT, higher taxes on all of this. SO what incentive do they have?

BUT let's look at the market from 2001 to 2008 when taxes were lower. Did we see the market shoot to the moon? Or did we see the S&P 500 achieve very close to its high the year before the "temporary tax cuts" of 2001 that lowered the capital gains tax. So when we had higher taxes and going to surplus we had retirees returning to work because companies needed workers AND a federal surplus. Sorry, I invest in indexes because I follow the data and the idea of some fear of taxes is not supported by any data.