Small-cap stocks have lagged the market this year, and the smaller the capitalization the more they have lagged.
The Model Shadow Stock Portfolio has a negative return of 9.6% year-to-date as of November 30, 2014, compared to a gain of 13.8% for the S&P 500 index as measured by the Vanguard Index 500 fund 
(VFINX).
With 30 days to go in 2014 as of this writing, this appears to be an above-average year for the overall market. But barring a wild December, it will be a rare down year for the Model Shadow Stock Portfolio.
The expected correction has still not arrived. It seems that every strong down day for the market is followed by up days and new market highs. The long-anticipated rise in interest rates has also been delayed and may be delayed further if lower oil prices contain inflation.
Medical Business Services Corp. (MDCI) was purchased by Owens & Minor and sold from the portfolio on October 1.
Also, after the close of the market on October 31, Kimball International (formerly KBALB, now KBAL) spun off its electronics division, resulting in the portfolio holding shares of Kimball Electronics that trade under the symbol KE. If you own this stock, you should have received 0.8 shares of Kimball Electronics for each share of Kimball International. Since the combination violates no portfolio rules, we continue to hold both stocks for the time being. Going forward, there should be separate financial results for each company, and we will evaluate them separately.
We finally had some new stock candidates to consider during our fourth-quarter review. After eliminating the Chinese stocks, the stocks we already owned and those with not enough liquidity, there were four candidates left. We have added two of these to the portfolio: Global Power Equipment Group (GLPW) and L.S. Starrett Co. (SCX). Final selection was based on liquidity and bid-ask spread. As a reminder to those following the portfolio without excess cash to buy the two new stocks, more than 20 stocks is not needed until your portfolio exceeds $20 million.
There are no deletions for the fourth quarter based on the portfolio sell rules. The stocks approaching value or size limits fell victim to the quarter’s stock price pullback, and no stocks were on earnings probation.
The current holdings in the Model Shadow Stock Portfolio can be viewed here, and all transactions can be viewed at the Transaction History page.
The mid-term elections are over, but there will probably be little impact from actual legislative change until after the January swearing-ins, which will be around the time you are reading this.
The timing of any Federal Reserve action to let interest rates rise remains a mystery. Action in the second or third quarter seems most likely. While higher interest rates make bonds more interesting in comparison with stocks, I don’t see that hurting stocks because it would only occur with a growing economy, which should increase earnings.
I do think that small-cap stocks will start to outperform large caps again. My hope, of course, is that any outperformance comes from small caps going up more than large caps, rather than from small caps declining less than large caps. As a long-term investor, I should be happy with the recent volatility and price weakness of small-cap stocks because that portends higher returns in the future. However, I am like everyone else and have a hard time with weak markets. Besides, I am looking for that Mystery Cycle +42.4% return in 2015 (see my October commentary here for an explanation).
I wish everyone a Happy New Year! The next Model Shadow Stock column will be in April 2015, but you can follow any updates here in the meantime.
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