For many stock market investors, 2005 turned out to be a mostly blah year. But for those holding shares in any number of locally based issues, it was anything but.
As of the close of trading on Dec. 28, local stocks measured by the LABJ 200 Index rose 6.2 percent, compared with the Nasdaq Composite Index’s 2.5 percent increase. The Dow Jones Industrial Average only eked out a 0.1 percent gain.
Why the difference? In part, because L.A.-based public companies are largely made up of small growth-oriented businesses, some of which are destined to be takeover targets. There’s also a scattering of successful large-cap companies like Occidental Petroleum Corp.
As was true last year, a number of factors played well for local stocks. That included the continued strength of the housing market, low interest rates, trade with Asia and a prosperous regional economy.
Among the 18 different sectors that comprise the LABJ 200 Index, only four posted negative returns. Communications was the biggest loser, shedding 21.7 percent, followed by computers, down 20 percent. Sectors with the strongest returns included Internet stocks, up 46.4 percent; health care, up 46.3 percent; and energy, up 42.7 percent.
Some large-cap stocks also outperformed the overall market, including Rosemead-based Edison International Inc., parent of Southern California Edison, up 34.03 percent to $43.03 a share; Los Angeles-based KB Home, which rose 39.8 percent to $72.96; and Calabasas-based Digital Insight Corp., up 74.6 percent to $32.13.
Those numbers are a far cry from the overall market, which faced a series of crosscurrents throughout much of the year. Only a rally in October managed to prop up the percentage gains of the major indexes, although only to the mid-single figure range.
“Most investors had bets that didn’t kill them, but didn’t make them heroes either,” said James Paulsen, chief investment strategist at Wells Capital Management, an investment advisory firm and unit of Wells Fargo & Co.
Focus on small caps
In some ways, the stock market reflected confusion with the new world order, in which Toyota Motor Corp. is expected to soon surpass General Motors Corp. in the number of cars produced and bankrupt airlines struggled to figure out new business models (with some success by the end of the year).
Technology stocks got pounded in the first half, but rebounded in the second. Growth stocks initially beat value players. Oil stocks dominated most of the year, but then derailed.
Paulsen, like others, is bullish on 2006. He shrugs off concerns about the Federal Reserve raising interest rates, primarily because the 13 rate hikes have totaled a mere 3.25 percent increase not much of a tightening and interest rates are still at near 40-year lows.
Small cap stocks, which make up a big portion of issues in the LABJ Index, will be the big performers in 2006, he said, since they tend to outperform in periods of rising inflation. And there’s plenty of evidence that small caps are already taking control.
The best-performing local stocks excluding those that trade below $10 per share were two apparel companies that sell high-end jeans, an indication that consumers are still spending.
Shares of True Religion Apparel Inc. rose 94.2 percent, to $15.73 a share, while Guess Inc. jumped 185.4 percent, to $35.82 a share.
Some niche health care players showed significant growth. Chatsworth-based Iris International Inc., which makes urinalysis systems and medical devices, jumped 126.4 percent to $22.07 a share, and On Assignment Inc., a Calabasas-based provider of temporary workers to the health care industry, rose 101.5 percent, to $10.46 a share.
Two upstart biotech stocks that both trade on the over-the-counter Bulletin Board posted significant gains. They include Beverly Hills-based Amexdrug Corp. which rose 1,150 percent, to $2 a share, and Los Angeles-based Clearant Inc., up 819 percent to $2.12 a share.
Mergers and acquisitions were also a big part of the story. In just the closing weeks of the year, Los Angeles-based Arden Realty Inc. was acquired by GE Capital and DreamWorks SKG was acquired by Viacom Inc.’s Paramount Pictures. Earlier in the year, ChevronTexaco Corp. acquired Unocal Corp. More dealmaking is expected in the first part of 2006.
Tom Taulli, who closely follows mergers and initial public offerings, expects that corporations flush with cash will go on a buying spree in 2006. “We’re not going to see a roaring bull market, but the main thing is a lot of big deals are getting done and that will reverberate through the economy,” he said.
Energy effect
Most market watchers believe energy will remain the dominant sector in 2006 based on demand from China and India, the growing gap between supply and demand and continued fighting in the Middle East.
“There’s a real popular misconception that energy companies will continue to do well as long as the price of oil remains high,” said Arthur Hogan, chief market analyst at investment bank Jefferies & Co. “But they’re going to have a terrific year even if gasoline stays above $40 per barrel.”
Hogan said the stock market jostling from rising energy prices did not accurately reflect corporate performance.
“We had good earnings and yet none of that was regarded in the market,” he said, noting that the companies making up the S & P; 500 churned out their 14th consecutive quarter of double-digit earnings growth, with earnings rising 13.1 percent, on average. “That means the market is forward pricing, it’s not celebrating last year’s earnings and not everyone believes we’re at the other end of the tunnel in terms of the end of inflation.”
Market watchers concede that the strong run-up in real estate has served as the primary investment vehicle for many households that previously had plowed their excess savings into stocks. With real estate prices leveling off, money on the sidelines is expected to pour back into equities.
But Rob Arnott, founder and chairman of Research Affiliates LLC, a money manager that is a sub-advisor to bond powerhouse Pimco, said investors are harboring illusions if they think stocks are going to throw off gains of 20 percent of more.
“The market is expensive,” he said, noting that he prefers value-oriented, dividend-paying stocks. “It’s up 5 percent to 6 percent which is in line with what we should expect from stocks in the future.”
Yet the economy remains quite strong, growing by 4.1 percent in the third quarter, and projected to grow by roughly 3.5 percent next year, a rate consistent with stable inflation.
“How investors feel about the market has very little to do with where they are going and everything to do with what they’ve been through,” said Paulsen. “So how people feel right now is going to have to catch up to reflect the stronger economy.”
