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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.