Investors turn to stock picking after massive rally

NEW YORK (Reuters) - After the surge in stock prices this spring when investors jumped back into the beaten-up asset class, attention is now turning to cherry-picking individual stocks in the right sectors.

The S&P 500 index climbed as much as 40 percent after hitting a 12-year closing low on March 9, helping all 10 S&P sectors advance in the second quarter.

But the drive was to snap up the most beaten-down companies regardless of outlook or fundamentals -- the 50 stocks in the S&P 500 that did the worst in 2008 were the best performers in the first half of 2009, according to Birinyi Associates, gaining an average 35 percent.

Now the focus has changed.

"The rally was probably fueled by an increase in stock exposure and now that's probably coming to an end, and instead of buying stocks for the sake of buying stocks, you need to buy the right stocks," said Cleveland Rueckert, market analyst at Birinyi Associates in Stamford, Connecticut.

With earnings season just ahead, equity investors are focused on stocks with strong fundamentals, albeit those with attractive valuations. They're looking largely for those that can benefit from a hoped-for rebound in demand by the end of the year.

Much of the market rallied between March and May, thanks to the emerging view that companies and the economy were not headed off a cliff.

A SHIFT TOWARD DISCERNMENT

Investors will not take such an egalitarian approach with this quarter's results, according to analysts and money managers.

"We will see a distinction between those companies reporting strong results and those not, as opposed to the first quarter when everything went up, even those companies with weak earnings and poor outlooks," said Tim Ghriskey, chief investment officer of Solaris Asset Management in Bedford Hills, New York.

In short, investors are hoping every company is like General Mills Inc (GIS.N). The cereal maker forecast better-than-expected earnings for the current fiscal year. It also said it saw "little" price increases for the period.

General Mills' stock gained 3.9 percent to close at $58.18 in trading on Wednesday on the New York Stock Exchange.

Thanks to the furious rally, the S&P 500 is currently trading at around 14.8 times average estimated earnings -- up from 12 at the start of March.

Investors are willing to accept a pullback, if only to get another chance to buy companies at more attractive valuations. That's part of the reason investors have been anticipating a correction that has so far eluded the market.

"If we're going to be exposed somewhere and we do have this nice pullback, we'd like to get more optimistic on something that is a little more beaten up, out of consensus and has more earnings leverage," JPMorgan analyst Stephen Tusa said in a recent conference call with clients.

Tusa likes diversified U.S. manufacturers 3M Co (MMM.N) and Textron Inc (TXT.N), Rockwell Automation Inc (ROK.N), and industrial conglomerate Ingersoll-Rand Co (IR.N).

To capture a cyclical upswing, equity analysts at JP Morgan have recently gone "overweight" on the industrial and material sectors and are now "overweight" in all cyclical sectors, including consumer discretionary and technology.

Just before companies report second-quarter results, Thomson Reuters data showed analysts are expecting cyclical sectors to experience the strongest earnings growth.

Sectors expected to do less well, according to the data, include consumer staples and telecoms, which are generally more stable and less dependent on the economic cycle.

(Editing by Jan Paschal)