Fundamentals Matter Again in 2012

NEW YORK (TheStreet) -- Wall Street has once again become a stock picker's market.

The combination of a U.S. credit downgrade by Standard & Poor's at the end of the summer and the escalation of European debt woes throughout the fall sent stock correlation -- the tendency of securities to move together -- to record levels. Investors panicked and pulled billions of dollars out of equities.

But investors need to fear no more as correlation has once again fallen to palatable levels and microeconomic news once again rules the trade.

As stocks moved as one in reaction to European headlines, individual stock picking became difficult throughout the fall. It seemed even a company with strong earnings, little exposure to Europe and great growth potential stood poised to drop just as much as its weak, loss-producing rival after the next headline out of Europe proclaimed the apocalypse was imminent.

At the peak of European fears the Chicago Board Options Exchange S&P 500 Implied Correlation Index reached as high as 91.54, where a reading of 100 means stocks move in lockstep.

Since that November high, the index has dropped to 70.88, the lowest level since September.

Meanwhile, the correlation coefficient of S&P 500 companies looks even more optimistic. The index dropped to 0.67 on Feb. 7 -- a level on par with pre-financial crisis norms -- according to data on the 50-day rolling average from Birinyi Associates in Westport, Conn. The index hit 0.86, its highest level ever, in October.

Oppenheimer chief investment strategist Brian Belski wrote last week that he expected the shift as stocks move from a macroeconomic to a microeconomic focus.

"2012 has been an entirely different story as correlations have fallen dramatically to their lowest levels in over the past 25 years," Belski wrote Feb. 3. "Since we believe that current stock correlation trends are likely to persist throughout the year, it is important for investors to place additional emphasis on active investment strategies."

But the shift also means investors must become more active and aggressive again to really benefit, he said, and recommended stronger emphasis on "underlying fundamental trends as opposed to more passive strategies."

In particular he says valuation factors, such as price to forward earnings and price to cash flow, and technical factors including relative strength are important indicators in today's lower-correlation environment.

"Those investors that focus on proper stock selection will be the ones to ultimately be rewarded," he said.

-- Written by Kaitlyn Kiernan in New York.

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