Even with Wednesday’s rally, December’s 11-13% declines (S&P 500, Russell 2000) for US stocks couldn’t have come at a worse time for markets. First, there is the psychological damage of seeing such a swoon in what is a typically good month for domestic equities. Then there is the magnitude of the decline, erasing solid YTD gains in just a few weeks and making 2018 the first down year for US stocks since the Financial Crisis a decade ago.

One underappreciated problem, however, (unless you happen to manage taxable portfolios) is how money managers and investment advisors had to respond to this sudden reversal of fortune. Put yourself into their shoes for a moment:

• In a few days your clients will see a year-end statement with declining bond, stock, and commodity asset prices. Pretty much nothing worked this year… That will sting, but after a decade of gains that is a manageable issue.
• But… Say you sold some large winners earlier this year as stocks began to roll over, perhaps the large cap Tech names that everyone from hedge funds to retail investors over-weighted until recently. Those were good sales, to be sure, but in a taxable account they create a future liability and your clients will have to cut a large check to the US Treasury in April 2019.
• To minimize the tax bill from those capital gains, you need to sell some losers to offset those winners. Clients understand market-to-market losses; they can be less forgiving, however, of out-of-pocket tax payments when there is no wealth effect of rising asset prices to soften the blow. Until September, those paper gains were there. Now, they aren’t.

Here is the real-world market impact of that problem. 

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