U.S. tech stocks have outperformed, but don't get used to it, says UBS

'We still favor value, cyclicality and small-cap,' the chief investment strategist at Northwestern Mutual Wealth Management told MarketWatch.

U.S. technology stocks may be leading market gains this week, outperforming after the Nasdaq Composite index snapped its recent losing streak, but don't expect that run to last too long, according to UBS Group's wealth management division.

"We don't expect this shift back toward tech will prove enduring, with market conditions continuing to favor other parts of the market," said Mark Haefele, chief investment officer of global wealth management at UBS, in a note Tuesday. "The tactical outlook favors the reflation trade over tech."

The outlook for company earnings in the reflation and value sectors next year is "comparatively attractive," with areas such as financial services and energy remaining poised to benefit from the COVID-19 vaccine rollout, fiscal spending and "pent-up demand," according to Haefele. Brent Schutte, chief investment strategist at Northwestern Mutual Wealth Management Co., agrees.

"We still favor value, cyclicality and small-cap," Schutte said Wednesday in an interview with MarketWatch. "The Fed is going to let the economy run hotter than they have in the past."

An accommodative Federal Reserve in the economic rebound bodes well for value and cyclical stocks, he said. Economic growth should "remain strong for well into another year plus," with the reopening of the U.S. economy getting a "tail wind" from a global recovery, according to Schutte.

In his view, many investors may be "clouded" by what they've seen over the past 13 years, finding "comfort" in U.S. large-cap growth stocks after the category led for such a long period. "Investors should focus more on valuation," said Schutte, who believes value stocks remain cheap relative to growth.

On Wednesday, the Nasdaq closed 0.6% higher for a 2% weekly gain so far that beat the two other major U.S. stock benchmarks. By comparison, the Dow Jones Industrial Average ended the day little changed, for a weekly gain of about 0.3%, while the S&P 500 rose 0.2% to advance 1% this week.

The Nasdaq also outperformed last week, posting a 0.3% gain as the tech-laden index advanced for the first time in five weeks. The Dow and S&P 500 ended last week with losses .

"While bouts of Treasury market volatility may occasionally revive pandemic-era mega-cap outperformance, we believe economic reopening and rising inflation remain the most potent near-term drivers for global financial markets," Haefele said in the UBS note. "We think the reflation trade has further to run."

Read: U.S. Treasury yields hold ground near 3-week lows

He also sees "limited scope for earnings beats" for mega-cap tech companies, which already have benefited from "significant upward revisions in analysts' estimates" for this year.

"Aside from potential buybacks, we see few obvious mega-cap catalysts that could drive a further rerating in stocks," Haefele said. "Within tech, we tilt our exposure toward small- and mid-cap names that have lagged the recovery, as well as long-term structural winners exposed to transformative, emerging industries."

The UBS CIO cautioned against being overly exposed to mega-cap tech following "a multi-year period of outperformance," suggesting that an allocation to that area should fall within the bounds of its representation in the broader stock market .

"Mega-cap tech names account for around 18% of global equities and about 25% of the S&P 500," he said. "A tech portfolio allocation somewhere between these two proportions offers a reasonable proxy for our neutral stance on technology."