Discover the Relationship Between Tax Season and the Stock Market

How Does Tax Season Influence Overall Stock Market Returns?

Tax season exerts a lot of pressure on taxpayers, and this pressure is not only felt by the taxpayer but also by the stock market. This is because, to fulfil the obligations of taxes, many individuals start to sell their stocks and money market funds, temporarily liquidating the stock and bond market. But how does tax season affect the stock market? It does in many ways, and this is what we will find: how tax season affects the stock market.

Key Highlights

  • Text season exerts pressure on the taxpayers and the stock market. Where many individuals sell stocks, and money markets want to meet their tax obligation, and it temporarily affects the market liquidity.

  • Despite having a sluggish start, the latter half of April rebounds in this stock market, where the historical data shows that the S&P 500 tends to be 1.7% higher on average.

  • Tax-related selling by investors can significantly decrease the market during the tax season.

Does Tax Season Affect the Stock Market?

The past pieces of evidence show that despite being sluggish in the first half of April, the other half of the month shows notable improvement. After the tax season, the S&P 500 tried to rebound, and the month's closing happened approximately 1.7% higher on average, implying a 75% success rate based on the data from 2000 to 2016.

During tax season, market decline due to tax-related factors can be significant. Many taxpayers sell their stocks to meet their obligations, creating a selling pressure. However, traders also leverage these expectations by strategically purchasing during any market weakness caused by tax-related selling. They then sell these stocks later in the month when the market tends to rally, capitalising on the market's post-tax season rebound. 

We have seen that the second half of April and May shows some strength in historical trends, suggesting that the subsequent six months represent a weaker period of the Year in alliance with the Halloween effect. In contrast, the six months after Halloween shows robust gain in the market—a period typically between November 1 and April 30. 

According to Yerdeni Research, from 1928 to September 2023, the S&P 500 index has shown a notable increase of about 5.3% from November 2 April. On the other hand, it has shown a modest gain of 2.4% from May to October.

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How Does Tax Season Affect the Stock Market, and Why?

If you look at the data from 2000 to 2016, it was found that the Standard and Poor's 500 index experienced an average decline of 0.2% and was only 41% likely to increase in the first two weeks of April. It is because of the tax season that influences the market in numerous ways. There is a connection between the taxpayer and the market where:

  • Investor liquidates their stocks and funds, including the short-term debt they have invested in.

  • Secondly, this increases the liquidity in the market and decreases the prices of stocks and bonds.

Taxpayers often go to their bank or money market accounts to cover their tax bills. Money market funds are among the best options for many investors as they have a low risky nature and liquidity and also provide great returns. However, when liquidity is in the market to address their tax liabilities, more pressure is exerted on funds and other assets they hold. This results in a decrease in the demand for bonds, which lowers their prices and increases the yields of the taxpayer.

The impact of tax-related liquidity on the market is extended beyond other assets, which follows the period of robust market performance, such as in 2023, when investors realise their gains on high-performance stock.

However, detecting these trends can be challenging as the market tends to anticipate and price further, which means any effect from tax selling will occur a week or months before it actually happens.

How Can Investors Prepare for the Stock Market's Reaction to Tax Season?

Despite the potential fluctuation, especially during tech season, investors are required to order their long-term investment strategy. April may provide minor fluctuation where many investors attempt to times a market that may not yield substantial results.

It is good to maintain a consistent approach, such as regularly contributing to your tax-advantage retirement account, such as a 401k and IRA. Hold on to your long-term goals, where you can align your returns with the overall market performance, which has delivered about a 10% annual gain.

Final Words

Tax season tends to influence the stock market where notable effects were observed in April; despite having a sluggish start, the latter half of April rebounded, and the S&P 500 was at a month higher on average, which reflects the overall historical success rate of 75%. There is a connection between the tax pair's action and market dynamics as tax often liquidates the stocks and funds to meet their tax obligation, which impacts the market liquidity and asset prices.

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