SPY: The U.S. Is Positioned To Expand Its Global Dominance

Investment thesis

My first bearish thesis about the SPDR S&P 500 ETF (NYSEARCA:SPY) did not age well, since the ETF rallied by almost 18% since late October. I am a mentally healthy person and will unlikely ever bet against the largest U.S. corporations from a long-term perspective. Still, I expected a temporary pullback back in October because valuations were going in the opposite direction with earnings. However, I have underestimated the ability of the American technological giants to unlock new massive growth drivers. Moreover, the U.S. economy is expected to outperform rivals in 2024 as well, which was also a big positive catalyst for the broader U.S. stock market. The U.S. is at the forefront of the current new artificial intelligence-driven wave of the digital revolution, and the massive cash pile accumulated by the largest American corporations substantially increases the chances that the technological gap between the U.S. and the rest of the struggling developed economies will continue expanding rapidly. The U.S. households look confident, and the Federal budget is expected to expand in 2024 across all key spending domains.

Why am I bullish now?

I want to start with the broadest perspective, i.e., from the macroeconomic level. Last year, the U.S. economy surprised analysts with its massive resilience despite the tightest monetary conditions since the beginning of the 21st century and political tensions within the country caused by various issues like the governmental debt ceiling, financial aid to Ukraine, student loan forgiveness, etc. At the same time, most of the other major global economies struggled. A big war is still ongoing in the middle of Europe, adversely affecting the whole continent. The Chinese economy demonstrated growth in 2023, but the pace of post-pandemic recovery was disappointing.

And 2024 is expected to be almost the same. According to J.P. Morgan Asset Management, a 2% growth for the American economy is projected for 2024, even though the Fed’s pivot in monetary policy is unlikely to be sharp. At the same time, China’s economic recovery in 2024 is expected to continue being “Slow and Bumpy”. Japan has lost its third place in the ranking of the world’s largest economies after slipping into recession. The outlook for the economies across Europe is also mostly cloudy. Given the ongoing struggles faced by major economies outside the U.S., juxtaposed with the anticipated notable growth of the American economy, the latter emerges as a safe harbor for capital from around the globe. This scenario is poised to be advantageous for U.S. capital markets, including evidently the stock market.

The U.S. stock market is likely to remain very attractive due to the safe harbor factor, which is very important given the current technological landscape. We are currently amid the new wave of the digital revolution, where advanced technologies like artificial intelligence [AI] and machine learning [ML] emerge. We are in high demand worldwide because of their broad application for different uses. The U.S. is at the forefront of this revolution, both from the software side and hardware. The U.S.-based Nvidia (NVDA) is almost a monopolist in the global graphic processor unit [GPU] market. The U.S. giants like Amazon (AMZN), Microsoft (MSFT), and Google (GOOG) hold cumulatively more than 60% of the global cloud infrastructure market. Apple (AAPL) and Meta (META) are creating new “Blue Oceans” with their ambitious virtual reality ventures, which can unlock new multi-billion industries where these U.S. giants are pioneering and are already far beyond their potential international competitors.

The technological factor is crucial because of the 30.6% weight of technology stocks in the ETF. To add context, the second largest sector in the SPY is health care, which is below 13%, i.e., its weight is more than two times lower than that of technology. The Magnificent Seven in total represents more than 28% of the total ETF, which means that the success of these companies significantly affects SPY.

It is also crucial that despite tight monetary conditions, there is a lot of cash in the bank accounts of the largest U.S. corporations. Let me look at the “Magnificent Seven’s” cash piles as of the end of 2023 [September 30, 2023, for NVIDIA only] plus Berkshire Hathaway (BRK.B). These companies have far more than half a trillion U.S. dollars in their bank accounts, which means vast potential to invest this cash in future growth. To add context, the cumulative capitalization of the German stock market is around $2.2 trillion. That being said, these eight U.S. companies theoretically have the potential to acquire nearly one-third of one of the largest European stock markets. This indicates that U.S. technological giants are poised to maintain substantial investment in the most promising startups worldwide and attract top talent from across the globe, thereby fortifying their significant technological edge.

If we narrow it down to the U.S. household level, I think that prospects are also bright. The U.S. consumer sentiment has been improving for the last three consecutive months, which is an indicator that households have adapted to the reality of higher interest rates and the aftermath of the high inflation of 2022-2023. Yesterday’s strong Q4 earnings release from Walmart (WMT) also indicates American households’ spending resilience and consumer confidence.

Everything also looks healthy for businesses from the governmental perspective level. The U.S. Federal budget is expected to expand in 2024 compared to 2023 across all significant spending line items, which will mean that businesses’ earnings from governmental contracts will also grow.

In conclusion, the U.S. stock market appears well-positioned to maintain its upward momentum, buoyed by a multitude of positive catalysts spanning crucial aspects of the economy: government spending, consumer confidence, and corporate investment in innovation. Moreover, the U.S. economy and capital markets stand out as an evident safe haven amid the challenges confronting other major economies.

Risks to my thesis

The substantial factor driving markets currently is FOMO, and once some negative news emerges, this might lead to a market correction. According to the CNN Fear & Greed Index, the market is now mainly driven by “Greed,” which means that FOMO’s portion of the rally in recent months is notable. Given that the S&P 500 is presently hovering near a significant psychological resistance level of 5,000, breaking through on a consistent basis might require time. Should the market linger around these levels for an extended period, it could potentially disappoint FOMO-driven investors, prompting them to sell off and triggering a pullback.

While I disagree with pessimists who compare the current situation in the stock market with the dot-com bubble, the average valuation of the S&P500 is higher than the historical averages. At the same time, the deviation does not look dramatic, and in the chart below, it looks like, in 2018-2019, the U.S. stock market was more “overvalued” from the P/E perspective than it is now. Furthermore, the historical P/E ratio overlooks significant earnings surges, exemplified by NVIDIA’s performance last year. However, a minor short-term correction could occur to align the valuation closer to the historical trendline. Yet, given the array of positive catalysts, there’s a high likelihood that corporate earnings will exhibit notable growth in 2024, potentially aiding in the smoothing of the P/E chart.

Bottom line

To conclude, SPY is a “Buy” at the current levels and is apparently a “Strong Buy” in case of a temporary pullback, which can happen due to the risks I have described. The U.S. economy continues proving why it is by far number one in the world because it demonstrates strengths across all key aspects: growing corporate earnings, vast investments in innovation, healthy households, and aggressive federal spending. Based on this analysis, I also believe that other major ETFs with exposure to the broader U.S. stock market apart from SPY are also attractive for investors. These include the iShares Core S&P 500 ETF (IVV) and the Vanguard S&P 500 ETF (VOO).

Since all three have almost identical exposure to the S&P 500 index, the returns are practically the same, but SPY lags slightly due to the slightly higher expense ratio. VOO and IVV are also good options, but I prefer SPY because it has a longer history tracing back to 1993 and a much higher average daily shares volume, which decreases liquidity risks for investors.

I am not recommending pure technology plays here, like the Nasdaq (QQQ) or the Technology sector (XLK) itself, because I think broader diversification will be less volatile for investors.