Finding Gems in a Stock Picker’s Market

To call the investment climate a “stock picker’s market” may sound akin to describing Death Valley as a hot place in the summer.

Uh, yes -- can you provide a bit more insight?

Yet there are times when hackneyed phrases may explain what’s happening on Wall Street as well as any verbose brokerage analysis.

Last year, for example, unquestionably was a rising-tide-lifts-all-boats market: As stocks rebounded from a three-year slide, 96% of industry sectors in the Standard & Poor’s 500 index posted gains in 2003.

In the first half of this year, by contrast, it would seem that the tide barely came in for the stock market, based on the performance of the S&P; 500 index: It is up 1.2% since Dec. 31 after soaring 26.4% last year.

But it was far less difficult to find exciting stocks than the S&P;’s struggle might suggest. It helped if you had a knack for picking up on good stories, particularly away from the beaten track.

Case in point: Potash Corp. This Canadian company would never make anyone’s list of glamour stocks. It produces huge quantities of farm fertilizer -- its namesake potash as well as phosphate and nitrogen.

A boring business, perhaps, but lately quite a profitable one. The company’s first-quarter earnings rocketed to $50.7 million, or 94 cents a share, from $3.2 million, or 6 cents a share, a year earlier, as farmers worldwide ordered more fertilizer to use on expanded plantings of wheat, corn, soybeans and other crops.

Last month Potash said second-quarter profit would top $1 a share, compared with its previous estimated range of 70 cents to 90 cents.

The stock hit a record high on the New York Stock Exchange on Friday, adding $1.94 to $97.60. That left it up 13% since the start of the year.

In the face of rising interest rates, soaring oil prices, mounting violence in Iraq and other woes, there still were enough good stories on Wall Street in the first half to keep many investors interested in stocks.

Whether you love or hate coffee roaster Starbucks Corp., there’s no arguing with the success of its shares this year. They’re up 37% since Jan. 1, to a record $45.54 as of Friday, as the company has continued to show double-digit monthly sales gains.

Ceradyne Inc., a Costa Mesa-based company whose ceramic body armor has become a hot product with the military, has seen its shares leap nearly 70% this year, to $38.50 by Friday.

Stocks of many smaller companies continue to perform better than blue chips, on average. That has been the trend since 2000, and it suggests that investors are looking further afield for interesting ideas.

A Standard & Poor’s index of smaller stocks is up 8.2% this year, much stronger than the blue-chip S&P; 500 or the big-tech-stock-dominated Nasdaq composite, which is up 0.2%.

There were enough winning stocks that mutual fund investors mostly will see good news on their midyear reports. The average U.S. stock fund was up 3.9% in the first half, according to preliminary data from Lipper Inc.

Nobody’s going to get rich in a hurry off a return like that. But to put it in perspective, the alternative was to lose money in bonds (most people probably did, as higher interest rates devalued older fixed-rate bonds in the first half) or to earn about 0.3% in the average money market mutual fund.

So stocks won the first-half race, providing a positive answer to the simplest question investors ask about their portfolios: Is my nest egg growing, or not?

Perhaps more important, the stock market’s ability to keep advancing has pushed aside an argument some bearish analysts had put forth at the end of last year -- that many investors quickly would take the money and run after the market’s stunning gains of 2003.

It was a flash in the pan, not a new bull market, the bears contended. But they were wrong.

The pullback in major market indexes in late winter and early spring looks to have been a garden-variety “correction.” For the numbers junkies: The S&P; 500, which reached a two-year high of 1,157.76 on Feb. 11, dropped 6.4% to its spring low of 1,084.10 on May 17. At 1,125.38 on Friday, it’s 2.8% below the February high.

Clearly, many stock investors are content to sit and wait. “A lot of people just haven’t done anything with their portfolios” this year, said Art Hogan, veteran market analyst at brokerage Jefferies & Co. in Boston.

That’s evident from the anemic NYSE trading volume of the first half, he said.

Stock prices have been underpinned by a basic optimism about the economy and by roaring corporate earnings. Operating earnings (that is, results before one-time gains or losses) of the S&P; 500 companies rose 27.5% in the first quarter from a year earlier, and are expected to be up 26% in the second quarter, according to earnings tracker Thomson First Call in Boston.

Nothing attracts investors like a hot streak in profit growth. Most factors influencing share prices are transitory; the long-term appeal of stocks is rooted in the promise of rising earnings.

On Friday, however, fresh economic data gave some analysts pause. The government said the economy created a net 112,000 new jobs in June. That was about half the number Wall Street expected, and it immediately fanned concerns that the U.S. expansion was slowing considerably.

That, in turn, raises questions about the pace of future earnings growth.

But the stock market seemed relatively unfazed. Most market indexes were fractionally lower. The Dow Jones industrial average slipped 51.33 points, or 0.5%, to 10,282.83.

Ned Riley, chief investment strategist for State Street Global Advisors in Boston, said it shouldn’t surprise anyone that the economy would ebb somewhat from the heady pace of the last year. He believes that will be good for the stock market, on balance, if it reduces what has become the biggest collective concern of late: rising inflationary pressures.

In addition, the Federal Reserve -- which just last week raised its benchmark short-term interest rate for the first time in four years -- might be compelled to lift rates at a slower pace if the economy decelerates, Riley said.

Wall Street bears might argue that the bulls want it both ways: They think they deserve higher stock prices whether the economy strengthens or whether it weakens.

But that also is the definition of a bull market, or at least a market in which the optimists outnumber the pessimists: Stocks tend to get the benefit of the doubt. People want to believe that things will work out OK.

Obviously, that doesn’t apply to all stocks. It didn’t in the first half. Shares of semiconductor giant Intel Corp. are down 18% this year on worries about its growth outlook. Aluminum industry leader Alcoa Inc. is down 15%, hurt in part by concerns about a slowdown in China’s economy.

Within the S&P; 500, 63% of stock industry groups are up in price this year, on average, while 37% are down.

“It sounds hackneyed, but it is a stock-picker’s market,” said David Dreman, head of Dreman Value Management in Jersey City, N.J.

On the face of it, small investors might consider a market environment like this to be too challenging. But there’s another way to look at it: Your chances of picking a winner might be just as good as any high-priced money manager’s.

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Tom Petruno can be reached at tom.petruno@latimes.com.