NEW YORK (Reuters) - U.S. mid- and small-capitalization stocks should continue to outperform the big-cap market next year as economic growth picks up, Bob Doll, chief equity strategist at BlackRock, said on Wednesday.
Earnings growth among mid- and small-caps should be strong enough to keep valuations attractive, Doll told the Reuters 2011 Investment Outlook Summit.
Doll, who favors U.S. stocks over other developed country markets on expectations U.S. economic growth will outstrip that of its peers, said he expects to see the stock market follow traditional trends as the economy strengthens.
“Typically in periods of economic re-acceleration, down cap outperforms up cap, and I think we’ll get some more of that,” he said.
“I would argue the earnings gains in that part of the market are going to be as good, if not better, than some of the big-cap areas in 2011,” added Doll, who helps manage more than $3.3 trillion in assets.
The Standard & Poor's MidCap 400 index .MID and the S&P SmallCap 600 index .SML each are up about 22 percent so far this year, compared with a gain of about 10 percent in the benchmark S&P 500 .SPX.
Doll reiterated a year-end 2011 target for the S&P 500 of 1,350. The benchmark index is currently trading at 1,226.
He is also looking at companies generating healthy free cash flow given expectations of a sluggish economic recovery.
“You want companies that have extra degrees of freedom. You want companies that have flexibility, and I think free cash flow is a great way to measure that, so they have choices should the environment be a little more topsy-turvy,” he said.
Sectors in which BlackRock is overweight at the moment include materials, energy and technology. Sectors in which it is underweight are consumer staples on a valuation basis and financials due to the lack of a clear view on future revenue growth as firms try and chart growth after the credit crisis.
“What is the new model for the financial sector and banks in particular to earn their money?” Doll said. “I don’t think we really know the answer to that question yet.”
Although financial stocks are benefiting from a steep yield curve, courtesy of the U.S. Federal Reserve keeping borrowing costs low while loan-loss reserve provisions are declining, Doll said those factors are is not enough to instill confidence in future profits.
”That’s good for earnings, too, but I‘m not going to put much of a P/E on either of those sources of earnings,“ he said. ”I want to know what is the revenue growth going to look like, and at the moment it is really hard to know, so that’s why we are underweight financials.
Companies he likes within technology are Microsoft (MSFT.O), IBM (IBM.N), Seagate Technology (STX.O) and Western Digital WDC.N. Within the energy sector, he likes Marathon (MRO.N) and ConocoPhillips (COP.N).
He also likes stocks within the health care and telecommunications sectors.
Looking at the overall market, he said, “The risk next year to me is more upside risk than downside risk. That is the big difference from the year we are just ending.”
Editing by Leslie Adler