Spotlight illuminates growth stocks

In a financial world suddenly starved for profits, a Wall Street slogan popular in the booming 1990s is making a comeback: Growth is good.

A performance shift is underway in the stock market, where growth stocks that have what it takes to post steady streams of profits in tough times are posting better gains than value stocks for the first time in years.

Many Wall Street strategists say the trend is likely to persist into the new year and beyond. Historically, when major shifts like this in the market occur, they tend to last three to seven years, says Jeffrey Kleintop, chief market strategist at LPL Financial Services.

The violent rotation into growth is evident among big stocks, small stocks and mutual funds. The Russell 3000 growth index, which tracks a broad basket of growth names, is up 11.1% in 2007, vs. a 2.2% decline for stocks in the Russell 3000 value index. Similarly, large-cap growth mutual funds were up 14% through the end of November, vs. a 3.3% gain for large-cap value funds. Small-cap growth funds were up 8.6%, vs. a 4.9% loss for small-cap value funds.

"We are in the first year of the shift," Kleintop says. "When earnings growth gets more scarce, it becomes more valuable."

Profits have been decelerating following the housing bust and credit crunch. Profit growth in the benchmark Standard & Poor's 500 index turned negative in the third quarter of 2007 for the first time since the first quarter of 2002, Thomson Financial says. Analysts expect profits to contract in the current quarter.

A growth stock is one that is expected to grow its earnings faster than the market. "They are going to perform pretty well no matter what happens," says Chris Orndorff of Payden & Rygel. Tech stocks such as Google goog and Apple aapl are classic growth stocks. Other businesses that traditionally fall into the growth camp include health care and firms that make discretionary consumer goods. The value camp is made up of slower-growing sectors such as financials and consumer staples, which are companies that sell everyday goods.

Next year, the Russell 3000 growth index is expected to grow earnings 15.8%, compared with 9.8% for the Russell 3000 value index.

Stocks that can post double-digit growth in a world where money managers expect the broad market to grow earnings in the low single digits in 2008 will be viewed as "superstars," says Steve Wood, senior portfolio strategist at Russell Investment. Value stocks have been leading the market since 2000, he says. LPL data show the Russell 1000 growth index, a basket of large stocks, posting a negative total return of 20.9% since the end of 1999. The Russell 2000 value index gained 70.5%.

"Nothing stays permanently good," says Wood, citing the eventual implosion of stocks in Japan in the late 1980s, tech stocks in the late '90s and real estate today.