Growth stocks may be down, but they're looking up to many money managers.
Over the past one and a half years, growth stocks have outperformed value stocks for the first time since 2000. This, say some money managers, could be a harbinger of things to come.
Will growth beat value in 2008? "It sure looks that way," says Edward Yardeni, president and chief investment strategist of Yardeni Research in Great Neck, N.Y. "Growth beat value for the first time in eight years in 2007 and is ahead so far in 2008 by an average of 383 basis points for the S&P and 107 basis points for the Russell."
All six S&P growth style indexes beat their value counterparts, but Russell style indexes are mixed. And growth earnings gains are expected to outperform value earnings because of write-offs in the financial sector in 2007 and 2008.
Yardeni also says that growth companies' forward earnings increased for the fifth straight month in July, while value forward earnings fell for the tenth straight month. The forward price-to-earnings ratio for growth, 12.5, was at a record low in July, but value's 12.2 price-to-earnings ratio is at about its mid-2006 low.
Ironically, growth stocks' price-to-earnings ratio in relation to their earnings growth rates, known as the "PEG ratio," is more attractive than value stocks' PEG. The PEG ratio for growth (0.94) is at record low and still below value's 1.14.
Financial research shows that Yardeni and others who like growth stocks selling at reasonable prices may be on the right track. Growth stocks tend to perform better than value stocks in a slow economic environment.
A working paper by Yuhang Xing, a finance professor at Rice University in Houston, found that value firms were more hurt by negative business cycle shocks than growth firms, which performed better in slow economic conditions. Xing comprehensively studied the cyclical movements in economic fundamentals for value and growth stocks in his working paper, "Value Versus Growth: Movement in Economic Fundamentals."
Robert Doll, chief investment officer at BlackRock in New York, agrees. "A focus on larger capitalizations, higher quality stocks and growth styles will continue to make sense in an environment of weaker economic growth and earnings," he says. "We would point to U.S. multinationals-companies that derive a significant amount of their revenues from overseas operations."
Doll favors information technology, health care and the energy sectors. He sees the U.S. stock market outperforming other developed markets.