To the casual observer, this week’s markets seem overly concerned with news that should have been expected and already priced into stocks. We know, for instance, that a recession means higher unemployment numbers, declining payrolls, and weaker retail sales. So why did it seem like investors ran for the exits this week after the buying spree of the week before? The answer lies somewhere between human nature and the tax code. Last week saw a market poised shake off months of pessimism in favor of the possibility that the economy would be turning soon. Stocks rallied as investors and portfolio managers bought to avoid being left behind in case a new bull market was emerging. Another common characteristic of investors is their tendency to hold positions with losses as long as possible hoping that time will reduce their losses. As the year comes to a close, investors must sell their losses to recognize them for tax purposes. Some years the process is orderly. This year’s tax selling season will likely be more erratic because of the significant losses sustained by investors in 2001, generally bad economic news, and disappointing quarterly corporate earnings reports. Sellers may panic into ‘selling at any price’ on market decline days, forcing some stocks to decline further than they would in more normal markets.
