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Is a Further 10% Rally in S&P 500 ETFs Possible?

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Bank of America (BofA) recently raised its 2023 price target for the S&P 500 to 4,300, representing a slight 2.9% increase from the time of writing, as quoted on Business Insider, published on Yahoo Finance. However, according to BofA's Savita Subramanian, the S&P 500 could potentially trade as high as 4,600, in a bull case scenario, marking the possibility of another 10% increase. Here’s why this is possible.

Shifting Corporate Focus Fuels Optimism

One factor contributing to Subramanian's increased optimism is the changing focus of corporations. Rather than relying solely on factors like ultra-low interest rates, cost-cutting measures, and stock buybacks, companies are now directing their attention toward efficiency, automation and artificial intelligence. This shift suggests a move toward long-term sustainable growth.

Favorable Macroeconomics

The macroeconomic environment is conducive to optimism due to the decline in inflation from its peak. The Federal Reserve's plan to keep interest rates steady is soothing investor worries about higher borrowing costs that could dampen economic activity. This favorable environment fosters a positive outlook.

Corporate Financials Likely to Mark a Rebound From Q3

The Q1 earnings season gave a consistent and stable performance, with companies surpassing expectations and offering a satisfactory outlook despite the unpredictable macro environment. As a result, the trend of revisions has recently shifted from negative to positive, marking a significant improvement after nearly a year.

Valuations Are Almost In Line With the Historical Average

The Federal Reserve's recent interest rate hikes and the ongoing reduction of its balance sheet have created some unease among investors. However, Subramanian noted that the stock market valuations are not extreme, with the S&P 500's forward price-to-earnings rate at around 19X. In fact, the broader market is currently trading below its 5-year average, Zacks Research.

She further highlights that excluding the top 50 stocks in the index brings the valuation to 15.7x, aligning with the historical average. This perspective challenges the notion that current valuations are excessively high.

A Far From Overbought Market

The market is not overbought, indicating room for more potential upside. Presently, only about 40% of stocks trade above their 200-day moving average, in contrast to over 70% historically during overbought periods, per Zacks Research. This dynamic suggests that a considerable segment of the market remains untapped by the current surge and has the potential to benefit from further growth.

Headline Risks Are Already Priced In

While acknowledging the existence of headline risks related to geopolitics, Fed policy, debt ceiling concerns, Subramanian asserts that these risks have likely already been fully digested by investors. In fact, stock versus bond allocations are at their lowest levels since 2009, suggesting that investors have already priced in the bad news.

Favoring an Equal-Weighted Basket Over the Index

In light of the valuation considerations, Subramanian recommends favoring an equal-weighted basket of the S&P 500 rather than investing solely in the index itself. By spreading the investments across all constituents, the basket offers a more balanced exposure and mitigates the impact of a few overvalued stocks. Invesco ESG S&P 500 Equal Weight ETF (RSPE - Free Report) and Invesco S&P 500 Equal Weight ETF (RSP - Free Report) should be noted here.

ETFs in Focus

Against this upbeat backdrop, investors may track S&P 500 ETFs like Vanguard S&P 500 ETF (VOO - Free Report) , iShares Core S&P 500 ETF (IVV - Free Report) and SPDR S&P 500 ETF Trust (SPY - Free Report) .

Investors can also play the growth part of the index with SPDR Portfolio S&P 500 Growth ETF (SPYG - Free Report) and the value part of the index with SPDR Portfolio S&P 500 Value ETF (SPYV - Free Report) . SPDR Portfolio S&P 500 High Dividend ETF Fund (SPYD - Free Report) is a good bet for the dividend plays of the index.

Investors can also bet on the leveraged S&P 500 ETFs like Direxion Daily S&P 500 Bull 3X Shares (SPXL - Free Report) , ProShares Ultra S&P500 (SSO - Free Report) and ProShares UltraPro S&P500 (UPRO - Free Report) while the index is on an uptrend.

Bottom Line

The market internals, sectoral performance, and P/E valuations support a case for a sustained rally. Furthermore, strong macroeconomic indicators such as easing inflation, steady interest rates, and rising personal incomes create a positive backdrop.

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