In the Index

All of us in the investment community watch “the market” pop up and down every day. But what is “the market”? What we look at to gauge our markets are stock indices, namely the S&P 500, the Dow Jones Industrial Average (DJIA), and the NASDAQ Composite Index. For the past couple years we’ve gotten used to seeing these move in-step with each other, but after the election we saw some pretty interesting daily differences in trading. Why is that? Because these indices are focused on illuminating slightly different markets. Below we’ll outline those differences to give you a better feel for what movements in each index represent.

How many holdings?

                S&P 500 – 500

                DJIA – 30

                NASDAQ – 3000

Who gets in?

S&P 500 – Companies with market cap exceeding $5.3 billion, headquartered in U.S.; sum of earnings for past 4 quarters is positive; listed on an NYSE, NASDAQ, or Bats exchange; certain liquidity & float requirements. Sector weighting supposed to represent general weight of all U.S. companies over $5.3 billion

DJIA – S&P 500 companies selected by an Averages Committee comprised of three members from S&P Indices and two members of the Wall Street Journal. Supposed to represent blue chip holdings in all sectors other than transportation and utilities. Companies have good reputation, sustained growth, and are of interest to large numbers of investors

NASDAQ – All companies listed on the NASDAQ exchange. I’m not going to get into listing requirements, but can accommodate much smaller companies than S&P 500 to the tune of around $500 million market cap vs. $5 billion. (This is a big reason it’s attractive to tech startups.)

How is it weighted?

                S&P 500 – Market cap weighted. Larger companies have more effect on index value

                DJIA – Price weighted. Securities with a higher price have more effect on market value

                NASDAQ – Market cap weighted. Larger companies have more effect on index value

 

Some things to point out

  • The NASDAQ is not set up as a tech exchange. It just works out that way because a lot of smaller companies are tech oriented. Lincoln Electric, a welding company started in 1895, is on the NASDAQ, probably not the type of company you’re thinking of when you think tech.
  • The Dow Jones is price weighted. A price move has same effect on the index regardless of how big a move it was to the company it happened in. It may be 1% move for a $100 company or a 10% move for a $10 company; both $1 moves to the index.
  • There is some notable overlap in these indices. All holdings from the DJIA are in the S&P 500. The S&P 500 can hold securities on the NASDAQ.

Looking at these indices and the rundown on their selection criteria, one may be shocked by the scant requirements to join a club that influences the world every day. Why wouldn’t you want to be more careful about the companies you pick with so many investing in them? Because indices like these weren’t designed to be investments, they were designed to represent a certain market and give us an idea of how companies in them are performing. These are the three the investment world has chosen to represent our domestic market, but today there are simply more indexes than you can shake a stick at. There are multiple indexes for stocks bonds and even fear. And more indexes are popping up in different sectors all the time for different purposes.

Point is all indexes aren’t created equal and it’s good to be aware of what an index is trying to show you before you decide if the movements you see are good or bad, or you decide if it’s a prudent investment.