Putting 'growth' in perspective

Does all this talk of an inevitable, eventual economic comeback have you thinking that the time to shift your investments into growth mode is now?

"I wouldn't bet the ranch on it," says Russ Kinnel, who heads equity research for Morningstar, the fund-tracking firm based in Chicago.

"There is no hurry to rush back into growth stocks," agrees Sheldon Jacobs, editor of the No-Load Fund Investor, a newsletter published in Ardsley, N.Y. "I'd wait until we see a clear turnaround, [perhaps] later this year."

For now, Mr. Jacobs says, an investor should have a portfolio with a little ballast to guard against stock shocks. He points to the standard array of diversifiers: bonds and cash holdings.

"But it's worth having some exposure to the sector," says Mr. Kinnel, who believes an investor should have somewhere between 10 percent and 20 percent of his or her stock portfolio in growth stocks.

Growth stocks are usually defined as companies growing their earnings or revenues faster than the overall market or their own industry, and with a focused objective of capital appreciation.

The question, of course: how to time a tilt toward the higher end of that range, and catch a growth-company resurgence.

Growth stocks – hotshot securities of the 1990s – seem powerless in the face of recent market turbulence.

According to Morningstar, large-cap growth stocks are down 24 percent for the year through Sept. 3. Mid-cap growth stocks are down 25 percent; and small-cap growth stocks are down 26 percent.

Just when it appeared that financial markets were returning to some modicum of growth – with the Dow up 18 percent between mid-July and mid-August – last week's downdraft suggested that a wall of worries, ranging from concerns about war with Iraq to dismal corporate earnings expectations, are dampening possible gains.

"Stocks remain in a bear market," says John Hussman, who manages the Hussman Strategic Growth Fund (www.hussman.net).

Recent market rallies, Mr. Hussman believes, are "bear-market rallies" rather than new legs of an expanding bull.

Hussman, despite the fact that his own fund is up an impressive 15 percent this year, remains wary about the market overall, and is not yet convinced that the US has fully emerged from recession.

That may mean going light on stocks for a while longer.

Hussman urges investors to keep saving – through bonds or money funds – so that when markets present a more favorable climate for gains, they can shift back into equities.

If individuals do invest in equities now, Hussman believes that they should look for funds with some form of hedging strategy, to avoid unexpected losses.

Hussman, a former economics professor, employs a complex proprietary hedging system that uses call options and includes a degree of short-selling against the S&P 100 and Russell 2000 indexes to preserve the principal in his fund, as well as eke out gains.

Hussman had scaled back his use of hedging this year in response to what had appeared to be an improving market. He was about 100 percent hedged in January; he is currently about 60 percent hedged.

But last week's market turbulence, with the Dow falling 4.1 percent on Tuesday, has him wondering if that move was a little premature.

The decline was such "a sharp deviance" that it suggests there is trouble somewhere in the economic or political/economic system, he says, although he is not yet ready to pinpoint what the trouble may be.

Even if current relatively favorable trends continue, says Hussman – and he says some positive moves were in the wind before last week – market gains will be modest, perhaps returning about 8 percent or so for the months ahead.

His own fund has succeeded in part because some of the firms he holds could also be characterized as value stocks.

Value stocks, which have been outperforming growth since 2000, are characterized by low price-to-earnings ratios and have inherent characteristics that make them attractive, even if they seem underappreciated by the market in general.

Companies Hussman has held this year include York International, Outback Steak House, PacifiCare Health Systems, Abercrombie & Fitch, Intel, and Lexmark.