Guidance for Following Portfolio Alerts
Thursday, June 19, 2014

How fast should you act in reaction to a portfolio addition or deletion alert?

A good general rule for following any portfolio, whether it is one of ours or one run by another organization (e.g., a newsletter service), is to buy when an addition alert is issued and sell when a deletion alert is issued. If you want to mimic the performance of the portfolio, it only makes sense to follow the changes. Acting quickly is prudent.

There is a difference between ‘quickly’ and ‘immediately,’ however. In the Model Shadow Stock Portfolio stock order guidance rules, we advise members to be patient. In the user’s guides for our Stock Superstars Report and AAII Dividend Investing portfolios, we suggest generally “acting on portfolio addition and deletion alerts within the week.” We follow up this statement by saying “don’t be afraid to wait longer if you feel the stock price is moving in your favor (falling if you are a buyer or rising if you are a seller).” In other words, don’t dawdle, but don’t feel rushed either.

The amount of patience you should use depends on the stock itself. A large-cap, widely held stock likely won’t be affected by a newsletter alert. We didn’t notice any unusual trading activity in Apple (AAPL) when we added it to our dividend investing portfolio this past April, for instance. Conversely, a smaller, less-followed stock may well be affected. Before the financial crisis, I once saw Movado (MOV) move upward by more than 10% in just a few days because Jim Cramer talked favorably about it on Mad Money. Lower volume will cause a stock to move in reaction to favorable or unfavorable comments or actions, especially if the portfolio or the commentator has a sizeable following.

We at AAII see this with some of the stocks we hold in our portfolios. We particularly see spikes in volume following an addition or deletion alert for our Model Shadow Stock Portfolio. This portfolio looks in the “shadows” of Wall Street to find small, undervalued companies. When a portfolio alert is issued, volume at the open of the very next day typically jumps.

This is what we observed on Monday with Alpha & Omega Semiconductor (AOSL). A portfolio deletion was announced on Friday evening, after the close of trading. (If you are not subscribed for the Model Portfolio Update emails, visit our email registration page.) On Monday, 414,700 shares traded—nearly seven times the three-month daily average according to Yahoo! Finance. The biggest volume spike occurred right after the market opened. While we can’t say with absolute certainty what caused the jump in volume, we believe market orders placed by AAII members over the weekend were the driver.

The best way to avoid the crowd of orders is to be patient. If possible, don’t trade right at the market open, but wait at least an additional 30 minutes. It’s even okay to wait a few days, as long as you don’t wait so long that you are not being disciplined in following the addition and deletion alerts. When you are ready to place an order, use limits to specify the maximum price you are willing to pay and the minimum price you are willing to sell at. Don’t be greedy, but do set them so you are not paying a price beyond the spread. Most importantly, double-check your order before confirming it. A few extra seconds to ensure your order is typed in correctly can help you avoid headaches.

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AAII Model Portfolio Update

As noted above, Alpha & Omega Semiconductor (AOSL) was deleted from the Model Shadow Stock Portfolio for violating earnings probation. This transaction brought the cash position in the Model Shadow Stock portfolio to 8%. In order to bring the cash position down to the maximum allowable 5%, the portfolio added additional shares to current holdings of SigmaTron International (SGMA) and Willis Lease Finance Corp. (WLFC). There were no transactions in the Model Fund Portfolio this month.

The Model Shadow Stock Portfolio lost 0.5% in May, underperforming the Vanguard Small Cap Index fund (NAESX), which gained 1.2%, and the DFA US Micro Cap Index fund (DFSCX), which gained 0.1%. For the year, the Model Shadow Stock Portfolio is now down 7.5%, trailing NAESX, which is up 1.3%, and DFSCX, which is down 2.8%. The Model Shadow Stock Portfolio has a compound annual return of 17.5% from its inception in 1993, while the Vanguard Total Stock Market Index fund (VTSMX) has gained 9.3% annually over the same period.

The Model Fund Portfolio performed better, gaining 2.1% in May, and the Conservative Portfolio (75% Model Fund Portfolio and 25% iShares Barclays 1-3 Year Treasury Bond ETF) followed suit with a gain of 1.7%. In comparison, the Vanguard Total Stock Market Index fund (VTSMX) gained 2.2%. For the year, the Model Fund Portfolio is now up 5.2%, ahead of VTSMX, which has gained 4.3%. The Model Fund Portfolio has a compound annual return of 9.7% from its inception in June of 2003, while the Vanguard Total Stock Market Index fund has gained 9.3% annually over the same time period.

The Week Ahead

Only one member of the Dow Jones industrial average will report earnings: Nike Inc. (NKE) on Thursday.

Eleven members of the S&P 500 will report their earnings: Micron Technology, Inc. (MU) on Monday; Carnival Corporation (CCL) and Walgreen Company (WAG) on Tuesday; Monsanto Company (MON), Bed Bath & Beyond (BBBY) and General Mills Inc. (GIS) on Wednesday; and on Thursday, Nike Inc. (NKE), Lennar Corporation (LEN), Accenture Plc (ACN), McCormick & Company (MKC) and ConAgra Foods Inc. (CAG) will report.

The first economic reports will be released on Tuesday, with the April S&P Case-Shiller home price index, May new home sales and June consumer confidence. May durable goods orders and the first-quarter final revised GDP will be released on Wednesday. On Thursday, May personal income and outlays will be released. Friday will feature June consumer sentiment.

The Treasury Department will auction $25 billion of one-year bills and $30 billion of two-year notes on Tuesday. On Wednesday, the Treasury will auction $35 billion of five-year notes. Finally, the Treasury will auction $29 billion of seven-year notes on Thursday.

What’s Trending on AAII

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AAII Sentiment Survey

Neutral sentiment jumped above 40% as optimism fell in the latest AAII Sentiment Survey. The increase puts neutral sentiment above its historical average for the 24th consecutive week. The last time we saw a similar streak was in 1999 (January 28 through July 8).

Bullish sentiment, expectations that stock prices will rise over the next six months, fell 9.5 percentage points to 35.2%. This large drop follows a three-week cumulative rise of 14.3 percentage points. It also puts optimism back below its historical average of 39.0% for the first time in three weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 6.6 percentage points to 40.7%. This is a four-week high. As noted above, neutral sentiment is now above its historical average of 30.5% for the 24th consecutive week.

Bearish sentiment, expectations that stock prices will fall over the next six months, rose 2.9 percentage points to 24.1%. The rebound puts pessimism at a four-week high. The move was not big enough to keep bearish sentiment from being below its historical average of 30.5% for the ninth straight week, however.

Neutral sentiment is back up to an unusually high level (one standard deviation above its historical average). As I discuss in this month’s AAII Journal, the S&P 500 has realized above-average six- and 12-month gains following unusually high neutral sentiment readings.

The drop in bullish sentiment follows a jump to what was nearly a seven-month high in optimism. A pullback in stock prices early in the most recent survey period played a role. There was also reversion back toward the sentiment readings we have been seeing in recent months. Some individual investors remain encouraged by the overall upward direction of stock prices, continued signs of economic expansion, the Federal Reserve’s tapering of bond purchases and low interest rates. Others are concerned about elevated valuations, the pace of economic expansion, Federal Reserve tapering and frustration with Washington politics.

This week’s Sentiment Survey results:

Bullish: 35.2%, down 9.5 points
Neutral: 40.7%, up 6.6 points
Bearish: 24.1%, up 2.9 points

Historical averages:

Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Take the Sentiment Survey.