Market Watch : Now, the California 300

In the 1980s, the California economy grew 50% faster than that of the other 49 states combined. With that kind of growth, you’d think the stocks of companies based here would have performed far better than the market, on average.

In fact, the opposite was true, at least from 1985 to 1989: An index of the 300 largest California companies, based on stock market capitalization, consistently under-performed the national Standard & Poor’s 500 stock index in that period.

But in the first half of this year, the California 300 was neck-and-neck with the S&P; 500. And some experts believe that the 1990s are going to favor stocks of California-style growth companies at the expense of the S&P; 500 behemoths.

The California 300 index is a recent creation of Associated Capital Investors, a San Francisco money manager that runs more than $3 billion. Associated’s CEO, Thomas Kelley, said the firm decided to launch the California 300 because no other benchmark existed to track stocks of firms based in the state, which has now become the sixth-largest economy in the world.

The index was given a value of 1,000 as of Feb. 28. Last week, the index stood at about 1,030. The 300 companies in the index range from Chevron Corp. and Walt Disney Co. to Barry’s Jewelers and Earl Scheib Inc.

The California 300’s sub-par performance in the late 1980s stemmed from its heavy weighting in oil and technology--both terrible investment areas in those years, Kelley said. Also, “growth” stock investing in general took a back seat to takeover mania and asset-value stock plays.

Now, Kelley believes that in the early 1990s, the smaller growth stocks that are a major part of the California 300 “are going to come back and have their day in the sun.” The move into those types of stocks may have begun with the surge in technology stocks in the first half of this year, some experts say.

Of course, no professional money manager would invest solely in California-based stocks. But if the California 300 begins to outperform the S&P; 500, it’s bound to be good publicity on Wall Street for California’s hottest growth stocks.

Associated Capital’s average portfolio posted a 4.2% gain in the first half, Kelley said, helped by stellar gains in a number of California-based tech companies. David Turnbough, Associated’s senior vice president, said the list of the firm’s favorite young tech companies now includes Irvine-based AST Research ($24.25 Friday), a major personal computer maker; Sausalito-based Autodesk ($54.50), which makes software for computer-aided design and drafting functions, and San Jose-based Xilinx Inc. ($15), which makes a new type of computer chip that can be programmed by the user for specific applications.

CALIFORNA VS. THE REST

How the California 300 stock index has fared versus the Standard & Poor’s 500 stock index, measuring total return (price change plus dividends):

Year Calif. 300 S&P; 500 1985 +29.4% +31.6% 1986 +12.0% +18.6% 1987 +0.2% +5.1% 1988 +15.2% +16.6% 1989 +28.8% +31.7% 1990 +3.1% +3.1%

Source: Associated Capital, Standard & Poor’s Corp.

Earnings Guessing Game: Earnings of the S&P; 500 companies fell 4% last year, and some analysts are worried that they’ll drop again this year if the economy remains weak.

Does that mean stocks are bound to go lower? Maybe not. Contrary to what many investors might suppose, the market has almost always risen in years when S&P; 500 earnings have dropped, according to research by Pasadena money manager Roger Engemann & Associates.

Last year, for example, the S&P; stocks gained nearly 32% (including dividends), even as earnings fell.

The simple explanation for that seeming contradiction is that the stock market always looks ahead--and by the time earnings are in trouble, many investors are already betting on the next up-cycle.

Earnings were weak in 1960-61, for example, yet the S&P; managed a 1% gain in 1960, then soared 27% in 1961. In the 1956-58 profit crunch, stocks dropped 11% in 1957 but soared 43% in 1958.

So even if second- and third-quarter earnings are disastrous this year and the market plunges, buyers could rush back in by the fourth quarter if they figure the worst is over. (Of course, we’re talking averages here; individual stocks that post awful earnings could suffer far worse than the broad market.)

Moreover, the problem with the market’s anticipatory nature is that it often trashes stocks temporarily when companies finally begin to show better earnings. In other words, when Wall Street anticipates correctly, the actual event becomes anti-climactic.

Which means that stocks might run a good chance of falling this year, or next, if earnings do indeed rebound. A big profit rebound in 1984, for example, was accompanied by a mere 5% S&P; gain, after a 20%-plus gain in 1983. Then, as earnings dropped 12% in 1985, stocks soared almost 32%--in anticipation of the next up- cycle. Sound convoluted? That’s why a lot of investors just ignore the short-term swings and focus on the long haul--because rising earnings will always translate into higher stock prices over time.

WHEN EARNINGS DROP

What if corporate earnings drop again this year, as they did in 1989? Here’s how the stock market handled back-to-back earnings declines in the 1950s and ‘60s:

S&P; 500 S&P; 500 Year earnings index 1951 -14% +24% 1952 -2% +18% 1956 -6% +7% 1957 -1% -11% 1958 -14% +43% 1960 -4% +1% 1961 -2% +27%

Source: Roger Engemann & Associates