The SPDR S&P 500 ETF Trust (NYSEARCA:SPY) is the most widely-watched index. That could prove to be slightly deceiving. SPY stock is heavily weighted on a few companies. These include Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT). Although investors may pick an equal-weighted index to remove the dependency, the index is still a good stock indicator.

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Since peaking on the first day of trading in 2022, investors should watch the index’s struggle closely. It could rally back to all-time highs, trade in a range, or break 52-week lows. Its trending direction will matter in the year ahead.

Technology Sector Weighs on SPY Stock

Bulls may wish for SPY stock to trade in an unstoppable uptrend in 2020 – 2021. That scenario is unlikely. During the Goldilocks period, the world faced lockdowns during the Covid-19 pandemic. Central banks pumped money into the market to avoid a credit freeze. The government issued stimulus checks to compensate people for staying at home and out of work.

The fiscal stimulus and monetary zero interest rate policies set stocks on an incredible run. Furthermore, software companies are one of the sectors that benefited substantially. For example, Microsoft’s sales of Office productivity software rose in the last two years. Nvidia (NASDAQ:NVDA), a graphics chip supplier, benefited from strong gaming card sales. Customers also needed its cloud-based server chips. In the information technology sector, Nvidia and Microsoft have a weighting on the S&P 500 index:

Data from S&P 500 ETF Trust.

The index is starting to show downside risks ahead. Adobe Systems (NASDAQ:ADBE) issued a light outlook that sent its shares trading sharply lower. It is among many companies that will face slower growth. Customers front-loaded orders to support a remote work environment. In the next year, Adobe is among the software companies that risk disappointing investors.

Breakout Opportunity

To break out again, the S&P 500 would need the U.S. Federal Reserve (the Fed) to raise rates only nominally. This scenario is very unlikely. The Fed previously assumed that the supply shortage is the only contributor to the high inflation rates.

Low interest rates and stimulus packages increased demand for goods. It also caused workers to re-evaluate their jobs. Some people who quit work opted not to come back to the workforce. For example, the pandemic lockdown shut down the service industry. Uncertainties from closing and opening businesses, driven by Covid-19 infection rates, created job instability.

In other industries, like banking and technology, workers are getting bonuses. Workers that ask for higher wages will create a permanent increase in company costs. This will result in permanent long-term inflation.

Inflation and higher interest rates will limit the S&P 500’s potential rally. Still, the interest rate increase cycle will eventually end. As the Fed gets closer to that in 12 to 18 months, the S&P 500 will trend higher.

Risks

Too many fund managers are relying heavily on the Fed limiting the S&P 500’s decline. They think the Fed put call will set a support level of 3,700. Historically, the central banks rescued stock markets in times of crisis. It did so in 2020 when markets feared the pandemic would create a depression.

In 2013, markets had a violent “taper tantrum.” The Fed scaled back its quantitative easing (or tapering). Bond yields rose sharply as stock markets sold off. Similarly, the 30-year Treasury bond peaked in December and fell steadily since then. The 10-year bond and the high-yield corporate bonds also fell as the S&P 500 declined.

Bond yields might keep rising in the months ahead. A government report on inflation surpassing the 10% level might increase bond yields. This will put significant pressure on the stock market. Still, the Fed already laid out an interest rate increase schedule. Rational investors should expect small rate increases of between 25 and 50 basis points after each Fed meeting. Markets should easily absorb the slow and steady rate hikes.

Your Takeaway on SPY Stock

The S&P 500 index has an attractive basket of companies among many growing sectors. The information technology slowdown is correcting for the pandemic-driven hyper-growth in the last two years. Growth will moderate as companies spend less to prepare for a remote work environment. That will not stop the need for technology spending.

The index is diversified enough to reward investors who are invested for the long term. The interest rate cycle may hurt stock prices today. This gives investors a chance to buy SPY stock at better prices. In the long term, companies like Microsoft, Adobe, Apple, and Nvidia are still growing faster than the average corporation. Chances are high that the index will trade at higher levels in three to five years than where it is sitting today.

On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.