INVESTORS WHO BEGAN

the new year believing the past is prologue took a beating in January, with the stock market doing almost everything it wasn't supposed to. Instead of rallying, equities were skittish. Technology stocks, where growth expectations have been strong, were among the worst performers for the month, while downtrodden financial firms held up.

In turn, value stocks, which most market watchers are writing off as definite underperformers in 2008, did remarkably better than favored growth stocks, with the smallest growth stocks doing the worst. It's a big enough reversal from the trends of late last year to wonder what's behind the shift and whether value stocks will fare better than many people think.

"We do believe there is more to recent value outperformance than short covering," Citigroup small-cap and midcap equity strategist Lori Calvasina said in a research note on Tuesday. She cites less attractive valuations of small growth stocks, as well as "the tendency of small-cap value to beat small-cap growth early on in recessions."

Large stocks still did better than small stocks overall, a trend expected to continue through the year. But style mattered. Large growth stocks fell 8% as a group in January, and small growth stocks lost 9%, according to the Russell benchmark indexes. Value stocks did considerably better, with both large and small value stocks falling 4%.

It's an impressive comeback, albeit a possibly short-lived one, for small-cap value stocks in particular. Last year, the Russell 2000 Value Index declined 12%, making it the worst among the major Russell benchmarks.

The Federal Reserve's interest rate cuts in December and January may be the key factor, giving financial stocks a boost. While growth sectors such as technology and health care suffered big losses, financial-services companies lost less than 1%.

Steve Scruggs, portfolio manager of the Queens Road Small Cap Value fund, says value stocks were also oversold in the fourth quarter of 2007. "Small-cap value is more weighted toward the financial sector, and with the surprise rate cuts small financial stocks really jumped," Scruggs says. Looking ahead, Scruggs also says small value stocks could hold up "better than growth and even the Russell 2000."

"I think we're in for a tough year economically, and value outperforms in environments like this," Scruggs says.

A big drag for growth stocks in January was the technology sector, which declined 12% on the large-cap Russell 1000 index and 14% on the small-cap Russell 2000. In addition, health care, usually seen as a safe haven sector, fell 5% and 8% on the large- and small-cap benchmarks, respectively.

Meanwhile, 12 of the top 25 performing stocks in January on the Russell 2000 were financial-services companies, such as

Impac Mortgage Holdings

IHOP

Stein Mart

Pier 1 Imports

But Citigroup's Calvasina says broader trends continue to favor growth stocks. She expects growth to beat value for the year given potential weakening in corporate profit margins and a recent uptick in high-yield credit spreads. Both factors tend to coincide with growth stocks doing better than value, she says. In addition, improving returns for growth-oriented mutual funds is "likely to bias retail money flows toward growth funds."

In the market's current turbulence, nothing is a sure thing, and January may yet prove a blip on the screen. But at least for now, value investors are enjoying a good start to the year.