How does SPY rebalance its portfolio without bleeding capital?

SPY is a passive, index-tracker that follows the S&P 500. In essence, the selection and weighting process has been outsourced to S&P, per their index methodology and rebalancing scheme.

S&P, on the other hand, has criteria for what companies are included, not included, added to, deleted from, etc. The index rebalances quarterly.

It is NOT as simple as just the "top 500 companies." After all, there are currently 503 constituents in the index. Turnover for the index is typically very low.

As for the trading within SPY, trades of the underlying securities within SPY, at State Street's direction as portfolio manager, coincide with index rebalances and raising money for dividend payments only.

Other than that, it's mostly set-and-forget.

For flows into and out of SPY, SPY doesn't need to trade the underlying. The market maker, as part of the creation/redemption structure, delivers (or receives) a basket of securities in the correct weights to match the index in exchange for shares of the ETF.

Again, the end result is relatively low turnover, low amounts of trading, part of the reason SPY and other index-tracking ETFs are so cheap.

We can talk about theoretical stuff (buying the S&P 500 could be considered a bit of a momentum play, for example), but the purpose of the index is to provide a representative sample of the US equity markets, which has ties into financial theory on the "market portfolio," which is theoretical "if you bought literally every single asset available in the world, what would the performance be, how could you measure relative attractiveness of a given investment within it, etc." That's the role the S&P, and by extension, the funds tracking it is trying to give: "for general equity investment, what should my returns be, etc."