The last three months have been remarkable for the AAII Model Shadow Stock Portfolio, both absolutely and relative to the market.

Figure 1. Model Shadow Stock Portfolio vs. Benchmarks (Through 11/30/06) CLICK ON IMAGE TO SEE FULL SIZE.

Year-to-date (through November 30, 2006), the portfolio is up 25.0%, which is an increase of 16.5 percentage points over the last three months. The market as represented by the Vanguard 500 Index fund (VFINX) is up 14.0% year-to-date, a gain of 8.3 percentage points over the last three months. Figure 1 on page 32 provides returns over various periods for the Model Shadow Stock Portfolio and comparison indexes.

As you can see, performance over both the long-term and short-term periods has well exceeded market indexes. We may be due for a weak year down the road, but that is best dealt with by building profits in the interim. The worst year in the portfolio’s 14-year history was in 1998, when it was down 8.9%. Interestingly, that was a good year for the general market.

Quarterly Portfolio Activity

Table 1 highlights activity in the portfolio during the last three months, and Table 2 shows the current holdings and their status in the portfolio.

All buying and selling was done in the latter part of November; as per the portfolio management rules, we only take action once a quarter. Dominion Homes (DHOM) and International Shipholding Corp. (ISH), which had been on probation, were sold because of continuing losses. TESSCO Technology, Inc. (TESS) was sold because it violated our upper value limit due to continued share price increases. We added California Coastal Communities, Inc. (CALC) and Rocky Brands Inc. (RCKY) to the portfolio. Because of recent market strength, there are fewer opportunities but we did find these two without changing the criteria.

Stock Order Rules

Sometimes you may have a difficult time buying issues within our portfolio rules. When it comes to our purchase guidelines, please think of our rules on spreads and volumes as general guidelines. There are various approaches one can take to avoid high spreads. One approach is to avoid trying for the full position all at once if you are buying more than $3,000 to $4,000 of a position. If you are paying less than $10 per transaction, the cost of multiple transactions may be less than the extra spread of doing it all at once. Larger orders may prompt market makers and day traders to raise their offer price.

You can play the market a bit by trying to buy on down days or watch a stock and see if there is a best time of day to buy. Many individuals place their orders overnight, so opening trades tend to exaggerate the price direction of the issue.

The performance of the Model Shadow Stock portfolio has been accomplished even though we have sometimes had to pay “extra,” with larger-than-desired spreads on our buys and sells.

Election Cycle: Early Anticipation?

In my October 2006 column, I pointed out that 2007 is the year before the presidential election, and that the year before a presidential election has always been the strongest year in the election cycle. In addition, I pointed out that many analysts believe 2007 could be a strong year for various economic reasons. My final point was that, with such anticipation for a strong year, the real strength of the move might come early and impact the last few months of 2006.

If this is what accounted for the strong move toward the end of 2006, then this next year, particularly the second half of 2007, might not be as bullish as has been anticipated.

The next Shadow Stock Portfolio column will be in April, but monthly updates can be found in the Shadow Stock Portfolio area of AAII.com.