It might not pay to play the `bounce' this year

ON THE MONEY

Your Money

October 21, 2007|By GAIL MARKS JARVIS | GAIL MARKS JARVIS,TRIBUNE MEDIA SERVICES

It's called "playing the bounce," a stock trading strategy that sounds like light entertainment, but isn't.

This time of year, traders try to take advantage of the tendency by fund managers to dump some of their ugliest stocks. The fund managers cleanse stock portfolios before the end of the year so unsightly stocks - such as homebuilders and mortgage companies this year - don't show up in year-end reports and scare off investors. Also, by selling losers in October, mutual funds reduce taxes clients must pay, offsetting the capital gains that winning stocks would otherwise leave at tax time.

Individuals sell for tax purposes, too, usually more heavily in November and December.

All the selling creates the opportunity for the bounce strategy, in which investors buy stocks that have fallen sharply from their peaks earlier in the year.

Stocks often weaken during autumn, but then frequently bounce up as investors anticipate a fresh start just before year-end or in January. So traders rummage through the stock market's garbage amid the selling during the fall, and buy stocks in the hope that they will be able to partake in a bounce and get out fast.

The idea is to pocket a quick buck, rather than to buy and risk another downturn.

But the bounce strategy, which has been tracked by analysts such as the Stock Trader's Almanac and the Leuthold Group for three decades, doesn't always work. People who dig through the stock market's rubble can end up merely holding garbage. And Leuthold warned clients recently that this year might be one of the years when it doesn't pay to play.

While an investor would have made more money during the last four years buying year-end sludge instead of a Standard & Poor's 500 index fund, a Leuthold report says the maneuver appears excessively risky this year.

The firm's list of bounce stocks is dominated by financial companies and homebuilders - stocks where bad news continues to flow.

"Clients who are astute stock pickers may enjoy the challenge of picking a bottom in some of these stocks, but this is no easy task," said Leuthold analyst Andy Engel.

Homebuilders are by far the worst area of the market, down about 50 percent for the year, according to Leuthold data.

Financial companies gained amid the relief from the Fed's 0.50 percent rate cut. But the stocks headed back down again recently as investors digested sobering words from Fed Chairman Ben S. Bernanke and hidden weaknesses in financial institutions became somewhat exposed.

Treasury Secretary Henry M. Paulson Jr. is facilitating discussions between large investment banks about setting up a fund that will help financial institutions avoid losses on financial transactions tainted by the mortgage mess. The structured investment vehicles and conduits, which would get relief from the fund, do not show up on banks' balance sheets.

For the year, financial stocks - especially banks, investment banks and consumer finance companies - are down about 7 percent. The S&P 500 is up more than 8 percent.

Bernanke said, "Conditions in financial markets have shown improvement since the worst of the storm in mid-August, but a full recovery of market functioning is likely to take time, and we may well see some setbacks."

He also suggested more deterioration in housing is likely.

Last year, playing the bounce provided investors a better return than the S&P 500. But the makeup of those bounce stocks was very different from this year's group. Many were energy and commodity stocks that slumped as investors apparently decided to sell in case the economy slowed in the coming year.

gmarksjarvis@tribune.com

Gail MarksJarvis writes for Tribune Media Services.

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