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Why It's a Stock-Pickers Paradise

NEW YORK (The Street) -- Investors who have seen returns hinge on central bank chatter and macro events can take a breather: the stock-pickers market is back.

As fears around Europe's economic stability and a sharp slowdown in Chinese growth recede, the direction of stock prices is increasingly driven by earnings quality and other fundamental factors. Check out the chart below, which shows stock correlation nose-diving. 

For investors, this spells a far stronger relationship between the quality of a company and its share price, rather than second-guessing central bank moves. It also means greater differentiation between individual stock prices and general market direction - in other words, less of a free ride from guessing macro-movements with solid rewards for research.

Yet against this backdrop, stock-pickers are feeling the heat from a rise in company valuations. After a run of 26% for the S&P 500 last year, bargains are thin on the ground, with several fund managers expressing skepticism that heady valuations will be justified over the coming 3-5 years.

Smaller companies are more expensive than their larger peers, following a 38.8% return for the Russell 2000 in 2013 while the Russell Microcap Index jumped 45.6%. Despite this, managers say there is still plentiful opportunity among smaller stocks:
(Isis, Teledyne and Pandora Among Top Small-Cap Picks)

In the absence of clear internal factors to justify higher stock prices, investors may well seek companies ripe for merger activity or agitation from activist investors. Those with high cash balances will be increasingly pushed to invest - or return funds to shareholders.

-- By Jane Searle in New York

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