The run of strong performance in smaller-cap stocks that began in December 2011 has carried through January and February, and micro caps have led the way.
The Model Shadow Stock Portfolio is up 17.2% year to date compared to 9.0% for the S&P 500 as measured by the Vanguard 500 Index fund 
(VFINX). The model portfolio is now at an all-time high.
Table 1 shows year-to-year performance, including the cumulative values of a $10,000 investment since inception of the Model Shadow Stock Portfolio in 1993. Notice the difference between the $185,923 present value of $10,000 invested 19+ years ago in the Model Shadow Stock Portfolio compared to $44,844 for VFINX and $56,358 for the Vanguard Small Cap Index fund (NAESX). What seems like a modest annual difference compounds very significantly over the years.
{{"object":2106,"classes":"object-type icon-html"}}The Model Shadow Stock Portfolio’s 16.5% annual average return since inception almost 20 years ago underscores a point made in Mark Hulbert’s article in the January 2012 AAII Journal (“Believing Performance Claims: A Triumph of Hope Over Experience”). Hulbert argued that 15% seems to be about the maximum long-term return possible without the additional techniques and leverage of hedge funds, which are not available to individual investors, or the ability to influence management behavior, which an investor like Warren Buffett has.
As shown on the Transaction History page, we sold three stocks. Lithia Motors, Inc. (LAD) was sold because it violated our size limit of $600 million market capitalization. It almost quadrupled for us, and we wish it happiness in someone’s mid-cap portfolio. Paragon Shipping Inc. PRGN was sold because it violated earnings probation. SureWest Communications (SURW) has agreed to a buyout by Consolidated Communications. Current shareholders will have to choose between cash and new stock, but our general rule is to sell when the board of a company agrees to a takeover.
The proceeds from these sales were used to make three purchases. We bought Ducommun Inc. (DCO), Medical Action Industries (MDCI) and Sterling Construction (STRL).
Our first pass of stocks meeting the purchase criteria showed 17 qualifying stocks. Three of these were Chinese stocks, which we continue to eliminate because of data uncertainty, and three were stocks we currently own. The final selection was based on a combination of low price-to-book-value ratio, low market capitalization, and high liquidity.
Since the 1930s, the third year in the election cycle had always been a slightly above-average 12% for the stock market. But four years ago the election year was one of the worst in history—down 37%. While the average election-year return since the Great Depression is still 10.3%, the recent behavior of stocks has departed from previous history, and the election cycle may not be much of a guide. One reason for this might be the growing importance of foreign factors: The election cycle has always been explained in terms of domestic spending activities, but other countries have different political and economic cycles.
I feel a bit more bullish than average, but not enough to change basic asset allocations. There is still a lot of uncertainty in the stock market. The election poses much uncertainty—not just about who will be nominated and/or elected, but about what the candidates’ plans really are. And the uncertainly extends beyond the presidential election to who will control the U.S. House and Senate.
We will examine the Model Shadow Stock Portfolio again in the July AAII Journal.
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