SPTM: Better Growth Outlook Than The S&P 500 Through 2026

seekingalpha07-21

The SPDR Portfolio S&P 1500 Composite Stock Market ETF includes 1,500 U.S. stocks in the S&P 500, S&P 400 and S&P 600 indices.As the Federal Reserve lowers its key interest rate, SPTM should benefit, ...

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At that time, we noted that SPTM represented about 90% of the U.S. equities market. We also noted that SPTM was expensive. However, inflation has cooled off considerably, and the macroeconomic environment has also changed significantly. We think it is time for us to analyze SPTM again and provide our insights. ETF Overview SPTM has a portfolio of 1,500 U.S. stocks. The fund basically tracks the S&P 1500 index which consists of all stocks from S&P 500 (large-cap), S&P 400 (mid-cap) and S&P 600 (small-cap) indices. The fund has underperformed the S&P 500 index in the current elevated rate environment due to its inclusion of small-cap and mid-cap stocks. Fortunately, as we enter a new cycle of rate decline, small-cap and mid-cap stocks should outperform large-cap stocks. In addition, these stocks trade at lower valuations to stocks in the S&P 500 index. SPTM's inclusion of not only large-cap stocks, but also small-cap and mid-cap stocks means it has a chance to outperform the S&P 500 index. Therefore, we think SPTM deserves a buy rating. Fund Analysis SPTM's growth in the past two years was largely driven by stocks in the S&P 500 index. SPTM has performed quite well in the past 5 years. As can be seen from the chart below, SPTM has delivered a total return of 97.1%. This was slightly behind the S&P 500 index's return of 100.7% but significantly higher than the S&P 400 and S&P 600's 68.5% and 59.0% returns respectively. SPTM's performance has largely been in line with the performance of these 3 indices before 2023. However, starting in 2023, SPTM and the S&P 500 index have outperformed the S&P 400 and S&P 600 indices by a wide margin as large-cap stocks tend to perform better in an elevated rate environment. Since SPTM's portfolio also consists of stocks from the S&P 500 index and these stocks have higher weightings than small-cap and mid-cap stocks, it is not difficult to understand why SPTM has outperformed the S&P 400 and S&P 600 indices. It is also not difficult to understand why SPTM has underperformed the S&P 500 index, as it also includes small-cap and mid-cap stocks. YCharts Growth will be better than simply owning the S&P 500 index through 2026 Fortunately, SPTM's underperformance to the S&P 500 index may soon reverse in 2025 and 2026 as we are in a different macroeconomic environment than the past two years. Inflation has dropped considerably from the peak reached in mid-2022, and the Federal Reserve is in the midst of preparing to lower its key interest rates. As soon as rates are lowered, small-cap and mid-cap stocks should benefit as these stocks typically have weaker balance sheets than large-cap stocks and because of this reason, small-cap and mid-cap stocks tend to underperform large-cap stocks in higher rate environment and vice versa. As can be seen from the chart below, stocks in the S&P 400 and S&P 600 indices are expected to have better annual earnings growth rates than stocks in the S&P 500 index in 2025 and 2026 respectively. Since SPTM also includes the small-cap S&P 600 and mid-cap S&P 400 indices, SPTM should be able to outperform the S&P 500 index.     2024 2025 2026   S&P 500 index 10.3% 14.9% 12.4%   S&P 400 index 1.0% 17.3% 14.7%   S&P 600 index -0.7% 21.9% 17.6%   Click to enlarge Earnings Growth Forecasts of S&P 500, 400, and 600 stocks Source: Yardeni Research, Created by author Valuation not as expensive as the S&P 500 index The two charts below shows the forward P/E ratios of stocks in the S&P 400 and S&P 600 indices. As can be seen from these two charts, the S&P 400 and S&P 600 currently trade at forward P/E ratios of 15.4x and 14.9x, respectively. These valuations are below their average valuations in the past 25 years. Therefore, we think these two indices are not expensive. Yardeni Research Yardeni Research In contrast, the S&P 500's forward P/E ratio of 21.1x is close to the near-term peak reached during the pandemic between 2020 and 2022 as shown from the chart below. Its current valuation is also close to the valuation reached during the dot-com bubble between 1998 and 2021. Therefore, SPTM's inclusion of the S&P 400 and S&P 600 makes it less expensive than the S&P 500 index. Yardeni Research Investor Takeaway SPTM is more diversified than the S&P 500 index thanks to its inclusion of mid-cap and small-cap stocks in the S&P 400 and S&P 600 indices. As we enter a new rate declining cycle, small-cap and mid-cap stocks are expected to outperform large-cap stocks thanks to their higher earnings growth forecasts and lower valuation. SPTM should benefit from this trend. Therefore, we are willing to give SPTM a buy rating.  Additional Disclosure: This is not financial advice and that all financial investments carry risks. 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