VFINX
The Model Shadow Stock Portfolio is down 9.3% year-to-date as compared to –3.0% for the S&P 500 index, as represented by the Vanguard 500 Index fund 
(VFINX).
The retreat by the model portfolio reflects not only the weakness in the overall market, but also the current weakness in value and small stocks.
While this year is not yet over and a rebound is very possible, the Model Shadow Stock Portfolio could trail the overall market for the second year in a row. This happened twice before—in 1998–1999 and 2007–2008, as you can see on the Year-to-Year Performance page. So far, the portfolio has never underperformed three years in a row, although it has been down or even for three consecutive years (1998–2000).
I am frequently asked, in reference to the Historical Return Chart, why the Model Shadow Stock Portfolio seems to have outperformed its benchmarks by such a wide margin in recent years. The explanation is that any series of returns over the long term will result in an upward curve due to the compounding of the returns; it’s the so-called magic of compounding. Some of you have suggested we should go to a logarithmic representation, where equal percentage moves appear equal, since the model portfolio return line is getting rather extreme on the chart.
Going forward, we are switching to a logarithmic chart for cumulative return.
There are no portfolio changes this quarter because we did not have a sell required for reasons either good (surpassing the value limit or size limit) or bad (violating earnings probation). The current portfolio can be seen here.
However, we had more stocks qualifying for purchase than we have seen in a long time. Even with my liquidity requirement added to the usual rules, there were 23 qualifying stocks. Five of these were either Chinese or already in the portfolio, but that still left 18 companies that met the initial purchase criteria. (At this point, we do not add any new stocks to the portfolio unless a stock is removed, freeing up funds.)
In the past, the expansion of qualifying stocks has gone hand in hand with a weaker market, and the eventual reduction in qualifying stocks after a maximum indicates an up market. However, our evaluation of this behavior as a possible early indicator of a market change proved that it was a lagging indicator and not a useful predictor.
The market keeps reacting to possible dates when the Federal Reserve may initiate a gradual raising of interest rates. In a sense, the reaction seems foolish. When we have good news about the economy, the stock market goes down because that means the Fed will stop supporting the market with low rates. It’s kind of like wanting to stay sick so the doctor won’t take away your medicine.
Eventually the market will forget the Fed and concentrate on the economy and particularly company earnings. I remember when the important thing to watch was the various measures of money supply, and the market would dance to that music. In any event, how much impact on rates can the Fed have if everyone in the world wants their money in U.S. Treasuries?
While I have given up on 2015 being super bullish because of the pre-election year boost and the year ending in “5” phenomenon, I still have a bullish bias.
We will discuss the Model Shadow Stock Portfolio again in the January 2016 AAII Journal. In the meantime, you can follow it here.
For the current purchase, sell and management rules, see to the Shadow Stock Selection Rules page.
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