SPY: Numerous Reasons To Remain Bullish
artpipi
Introduction
I had a ‘Strong buy’ thesis for SPDR S&P 500 ETF Trust (NYSEARCA:SPY) in April. The stock returned to investors 7.7% since April, which I consider to be a solid performance. I also think that there are a few more solid reasons to remain firmly bullish. The U.S. economy is strong and is backed by growing corporate profits, healthy consumers, and expected consistent growth in governmental spending for the next decade. In addition, inflation keeps going down, and it is very likely that the Fed will start cutting rates soon. Therefore, I am inclined to reiterate the ‘Strong buy’ rating for SPY.
SPY is not the only one mega-AUM ETF tracking performance of the S&P 500 index. There are also ETFs like the iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 ETF (VOO) with almost identical holdings. However, SPY is by far more popular and liquid and that is the main reason why I prefer it over competitors. Readers can easily compare these three ETFs with the help of Seeking Alpha’s tool called “Peers”, the comparison between SPY, IVV, and VOO can be found here.
Fundamental analysis
In my opinion, financial performance of the U.S. largest 500 corporations is the number one fundamental factor that we should be looking at. The top-10 largest companies are the ones that affect the ETF the most, and it is vital for investors to understand expectations about these companies’ financial performance in Q2.
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All companies representing SPY’s top-10 holdings are expected to deliver EPS growth in the upcoming quarter, which says a lot about the strength of corporate America. Moreover, consensus expectations are mostly aggressively improving, with lots of upward revisions for six companies out of nine (Google is represented with two stock classes in the top-10 SPY’s holdings).
Compiled by the author
All these companies dominate globally across all the hottest trends: artificial intelligence (‘AI’), cloud transition, digital advertising transition, virtual reality, weight-loss drugs, and etc. All these companies, except Berkshire Hathaway (BRK.B), are exporting their cutting-edge solutions and products globally, and their aggressive spending on R&D helps in cementing their status of the world’s most innovative ones. Total TTM R&D spending of the largest companies in SPY, except for BRK.B, amounted to $255 billion. This amount is close to the cumulative R&D spending of Germany and Japan, the world’s third and fourth economies, respectively.
Compiled by the author
Furthermore, all these companies have accumulated massive cash piles. The total cash balance of these giants was $442 billion as of the last reporting date, and Berkshire Hathaway had another $189 billion in ‘dry powder’. That said, the potential of the largest American companies to continue investing in innovation and growth is huge. As companies are likely to discover new growth drivers through innovation, they will highly likely create more value to shareholders.
Compiled by the author
Apart from the massive potential to create and export innovation across the world, the U.S. itself is the world’s largest economy. There were fears when the Fed started its monetary tightening cycle, but the resilience of the U.S. economy in Q1 2024 means that ‘Soft Landing’ was successfully achieved. This success is remarkable, especially when we recall that the economies of Japan, Eurozone, and the U.K. faced recession in 2023-2024. Chinese economy is not in recession, but growth pace is in decline. I think that this contrast between the U.S. and other large economies also boosts confidence in the resilience of the U.S. stock market, which is another solid positive catalyst.
Resilience of the U.S. economy is not only underpinned by corporate America, but also due to healthy wealth of households. American households’ wealth is at record high, while unemployment rates are still close to historical minimums. Moreover, U.S. real average hourly earnings continue demonstrating growth after bottoming out in summer 2022. To summarize, from the perspective of consumers, the U.S. economy also looks strong.
Another crucial factor which will highly likely continue to support the U.S. economy and the stock market is governmental spending. According to the Congress, governmental spending will grow from $6.77 trillion to $10.03 trillion between 2025 and 2034, which is a 4% CAGR. Therefore, it is expected to show consistent growth, which will also significantly support the macro environment.
A factor that is also vital for the stock market is the Fed’s monetary policy. The situation looks good from this perspective, and interest rates were quite steady over almost a year, meaning that the probability of new hikes is very low. Moreover, there is an opportunity that the Fed might start cutting rates in 2024. Softer interest rates will help in driving down discount rates. This will be beneficial for growth stocks because lower interest rates mean a higher present value of future cash flows.
Mitigating factors
Last week’s debate between Joe Biden and Donald Trump, the two only candidates left in the U.S. presidential election race, was the big event that can be harmful for the stock market. Softly speaking, Joe Biden’s performance during the debate was not flawless, and now there is a probability of the Democratic party replacing him as a nominee for elections. Such sharp moves just a few months before elections might be adverse for the reputation of the U.S. as the world’s most politically stable country. The strength of the U.S. political system is one of the pillars that make the whole world believe in dollar and the U.S. stock market. Therefore, failing to maintain this reputation might have an adverse effect on the stock market.
According to currentmarketvaluation.com, various indicators suggest that the stock market is significantly overvalued at the moment. I disagree with these conclusions because they compare current metrics with historical long-term trends, which does not appear to be fair. In my opinion, artificial intelligence is one of the most disruptive megatrends over the last several decades and generative AI has the potential to save trillions for the global economy by saving billions of working hours annually. All these savings will capitalize in corporations’ bottom lines, which will smoothen currently high valuation ratios. On the other hand, the P/E model shows that the current valuation moves closer to the late 2021 levels before the 2022 market selloff started. Therefore, some kind of correction might happen, but I do not expect it to be deep or long-lasting.
currentmarketvaluation.com
Conclusion
As an investor who makes investment decisions based on fundamental factors, I think that everything points to the rally in the U.S. stock market should go ahead. There are numerous robust bullish indicators that support my bullish stance, and my position looks well-rounded. I prefer SPY over its closest peers like IVV and VOO because it is by far the most popular ETF with much greater liquidity.