Year-End Selling Puts a High-Risk Spin on the Game

Everybody’s looking for a bargain, but that game gets a lot riskier in the stock market at this time of year.

Over the next few weeks, be prepared to see the poor get poorer and the rich get richer: Many stocks that have tumbled this year could plunge even further, while the strongest stocks are likely to attract new money.

The reason is year-end tax selling. Investors who have held onto dogs that show little hope of a turnaround often give up and sell around now, under the pretext of needing tax losses to offset their capital gains for the year.

That can lead to the abrupt collapse of stocks that Wall Street figured couldn’t get much cheaper.

A couple of cases in point are Torrance-based retailer Standard Brands Paint, and Perris-based Modtech Inc., which builds modular classrooms:

* Standard Brands had fallen from $10 earlier in the year to $4.75 by the end of September, pulled down by dismal earnings. Last Thursday, out of the blue, the stock was knocked as low as $2.50 before recovering to $3 on Friday.

* Modtech, another earnings disaster, had fallen from a 1991 high of $13 to $4.75 early in October. Last week it slumped to $3.125, and closed at $3.625 on Friday.

There was no news from either company to affect their share prices, and the stock market overall was rallying strongly last week. That suggests tax selling was the culprit in the stocks’ latest declines.

“I don’t see a great abundance of it yet, but I do see the beginnings of tax selling,” said Larry Rice, manager of over-the-counter stock trading at Wedbush Morgan Securities in Los Angeles.

What’s more, the effect of tax selling is likely to be compounded this year because so many investors are playing the “momentum” game. More than ever, they want to be in stocks that are going up now , and they’re unwilling to have patience with laggard stocks.

“A lot of guys are getting rid of their losers and buying the winners, not so much for tax losses but just because of the pressure to get out of non-performing stocks and get into ones that are performing,” says Larry Friend at investment firm L. H. Friend, Weinress & Frankson in Irvine.

For small investors, what’s important is that you recognize the risks and opportunities that arise with tax-selling season, and set your strategy accordingly:

* If you’ve been holding a lousy stock and want to sell for tax reasons, at this point you might be better off waiting until late in December. If many other investors start pushing the dogs out of their portfolios in coming weeks, as expected, the stocks could soon be bloodied as badly as Standard Brands and Modtech.

By December, however, the bargain-hunters who wait for tax selling could be out in full force, pulling many of the more promising stocks back up.

* If you’re a potential buyer, on the other hand, you may want to be actively casing the market for deep-discount bargains in November, rather than wait until December or early January--the traditional time for bargain-hunting.

* Whether buyer or seller, recognize that not all depressed stocks will necessarily drop further. Tax-selling is much more likely to affect thinly traded stocks, stocks of small- to medium-size companies, and those more heavily owned by individuals and speculators. Institutional investors, such as pension funds, don’t have to worry about taxes, so they aren’t a major factor in year-end selling. Thus, the blue chip stocks that they own often are less vulnerable.

* Don’t assume that a stock is a bargain just because it has dropped 30% to 50%. Certainly, some of this year’s losers--such as health-maintenance organization FHP International and Pacific Enterprises (which owns Thrifty Drug stores and Southern California Gas Co.)--aren’t in danger of going out of business. But unless you can see an earnings turnaround in 1992, these stocks could be dead money for a long time to come.

What if you have large paper losses in a stock, but you still believe that it will recover in the long run? You could sell now to lock in those losses for the 1991 tax year, then buy the shares back later.

But don’t forget about the Internal Revenue Service’s “wash-sale” rule: If you sell and then buy back the same security within 30 days, any tax loss that you realized is void. So you’ll have to wait at least 31 days between buying and selling.

Finally, some experts warn against making stock decisions solely based on your fear and loathing of the tax man. “I don’t necessarily believe in selling just for tax purposes,” says Bob Bryar, head of Strategic Tax & Financial Planning in Sherman Oaks. “Maybe taxes influence your decision, but you really have to look at a stock as an investment” first, and judge it on its own merits.

No Money Fund Relief: With money market mutual fund yields below 5% for the first time since 1977, some investors may wonder why fund managers aren’t scrambling to do something--anything--to boost yields. The answer is, there’s not much they can do.

The funds typically own short-term CDs, corporate or U.S. Treasury notes that mature in 90 days or less. The current average maturity of money fund investments is 63 days, according to fund-tracker IBC/Donoghue’s in Holliston, Mass. That’s the longest in more than a decade, and compares with an average maturity of 54 days last June.

The funds could buy longer-term paper (say, 80 days) and earn a slightly higher yield for investors. But then they’d risk running afoul of the Securities and Exchange Commission, which wants the funds to keep their investments relatively short-term, and thus safe, says Don Phillips, editor of Mutual Fund Values newsletter in Chicago. The money funds have always managed to keep their share values constant (usually at $1), but that record could be jeopardized if they begin taking risks with longer-term paper.

Most money funds also have a more selfish reason for allowing yields to drop: Their parent companies may turn a higher profit if unhappy investors switch from money funds to stock and bond funds in the same fund family. Money fund managers usually take just 0.6% to 0.7% of fund assets for management expenses each year; in contrast, Phillips says, stock fund fees average 1.25% of assets, and taxable bond fund fees average 0.98%.

Briefly: Bad news for dividend fans: A total of 102 companies raised cash dividend payments to shareholders in October, down 11% from the 115 companies that raised dividends in October, 1990, Standard & Poor’s Corp. reports.

September had shown the first year-over-year rise in dividend increases in two years (63 companies versus 56 in September, 1990), but S&P; warned then that it was too early to say the long decline in dividend generosity was over. October bore that out. Dividends depend on healthy corporate profits, and most companies still are struggling. . . .

While dividends are dull, high-yield corporate junk bonds had another great month in October: First Boston Corp.’s index of junk bonds posted a total return of 3.3% for the month, far outpacing the 1.2% rise in the S&P; 500 stock index. . . .

Does anyone believe it’s a total coincidence that the Federal Reserve has now twice lowered interest rates just before the big quarterly bond sale by the U.S. Treasury?

The Fed was politically pressured to cut rates during the first week of August, in tandem with the Treasury’s sale of $38 billion in notes and bonds that week. This week, the Treasury steps up to borrow another $38 billion--and sure enough, the Fed has once again obliged, pushing rates down last week. The White House, struggling with a record federal budget deficit, needs all the help it can get in controlling spiraling interest costs on the federal debt. Every Fed rate cut helps.

Tax-Selling Targets?

Here are some Southland stocks that have performed miserably this year to date, potentially leaving them vulnerable to a further drop if remaining investors bail out for tax reasons between now and year’s end.

1991 Fri. Change Stock high/low close Yr. to date Pinkerton’s 32 3/4-20 21 3/4 -3% Sizzler International 18 7/8-11 1/2 11 5/8 -7% National Medical Enterprises 25 3/4-16 16 3/8 -13% CalFed 8 5/8-2 1/2 3 1/4 -26% FHP International 29 3/4-9 7/8 10 3/8 -32% Pacific Enterprises 43 3/8-24 1/4 25 1/4 -35% Community Psychiatric 40-12 1/4 13 3/4 -53% Standard Brands Paint 10-2 1/2 3 -57% Modtech 13-3 1/8 3 5/8 -62% S&P; 500 index 398-309 391.32 +19%

All stocks trade on NYSE except Pinkerton’s, FHP and Modtech (NASDAQ).