Investors may sell profitable positions in early 2023 to delay paying taxes
The tax code incentivizes investors to act in certain ways. For instance, investors may wait until after the new year to sell profitable positions to delay paying taxes on those gains. Knowing this, perhaps we can identify early-year rallies for a handful of stocks.
Highly shorted stocks that have done poorly in the past year might be prone to early-year rallies, since short sellers who have profitable positions might be waiting until after the new year to cover those shorts. This week, I’m seeing if we can detect stocks with a good chance to rally early into 2023.
Can we spot short-covering rallies?
The first table shows data on stocks for the first week of the year from 2018 to 2021, with the first three columns consisting of those with high short interest broken down by returns from the year before.
If my theory is correct, I would expect the highly shorted stocks that were down significantly in the year prior to outperform early in the new year. There is evidence of that looking at this data. The worst performing, highly shorted stocks averaged a 6.68% return in the first week of the year, with 64% of them beating the S&P 500 Index (SPX).
Stocks that were positive in the year prior also performed well, though, averaging a 5.31% return, with 59% beating the SPX. Stocks that were highly shorted and down moderately underperformed for some reason. Based on this data, this could be a good indicator, but a stock being highly shorted seems more important than how it performed the year before.
The table below shows numbers for the past year. If we had used this indicator in the first week of 2022, we would have done an awful job. The highly shorted names down big in 2021 lost 7% on average in the first week of the new year, and only 23% of those stocks beat the SPX.
Disregarding the highly shorted stocks down moderately, where there were only six returns, the best performing group were those highly shorted but positive in the year prior. Those stocks gained 0.58% on average, with 57% beating the SPX.
Potential short-covering rallies for early 2023
While the data above isn’t entirely convincing, I think there’s enough there to warrant keeping an eye on some stocks. Below is a list of 25 stocks that are down at least 10% in 2022, with at least 10% of their float sold short.
These stocks are highly shorted and beaten down, which could lead to a short-covering rally early in the year, as traders who are short and profitable may be waiting for 2023 to cover and realize the gains. Additionally, this list could serve as a confirmation indicator for those considering purchasing a technically weak stock.
