Is the stock market up 7% or 37% this year?
Well, it depends. According to one major index, the market is up a respectable 7%. That’s not bad following last year’s dismal performance, but contrast that with another well-known index, and we might conclude that the stock market is up nearly 20%.
Sounds great, right? Well, it is, unless we compare it to a third index, which has soared 37% since the start of the year.
That said, let’s name some names. The Dow Jones Industrial Average is up 7%, the S&P 500 is up almost 20%, and the tech-heavy NASDAQ Composite is up 37%.
That’s a huge disparity. Which one is correct? They all are, but performance is based on how the indexes are constructed.
Let’s start with the Dow. The Dow Jones Industrial Average is the oldest and best-known index. It debuted in 1896. Today, it is made up of 30 large companies.
In order to get today’s value, you simply total the 30 stock prices and divide by what’s called the Dow Divisor.
Why not divide by 30? The purpose of the index divisor is to maintain the continuity of the index amid stock splits, mergers, spinoffs, and more, which have complicated the arithmetic.
As of a month ago, the divisor was 0.15172752595384.
From a practical standpoint, you can quickly see how a high-priced stock, which might rise or fall by 10%, will have a larger impact on the Dow than a lower-priced stock, which rises or falls by 10%.
Additionally, the index includes blue-chip companies that tend to be slower-growing but more established. The Dow typically doesn’t decline as much in a down market, as we saw last year. It may not rise as much in a bull market.
But 2023’s discrepancy between the major indexes is unusually large.
That leads us to the S&P 500 Index, which is comprised of about 500 firms and covers about 80% of the market. Market professionals commonly use the S&P 500, rather than the Dow, as a benchmark and when discussing overall stock market performance.
Unlike the Dow, the S&P 500 is a market-capitalization-weighted index, which means that the larger companies, determined by their respective market capitalization (the number of shares outstanding x share price), have a greater impact on the index.
For example, the top seven stocks account for about one-quarter of the index.
This year’s impressive performance can be attributed to the significant contribution of super-sized tech giants, including Apple (AAPL), Microsoft (MSFT), and Nvidia (NVDA), which have performed particularly well.
This dovetails into the NASDAQ Composite, which is heavily skewed toward technology stocks. Like the S&P 500, it is also a market-capitalization-weighted index, and the big tech names have driven this year’s stellar performance.
There are about 3,500 securities on the NASDAQ, but just two, Apple and Microsoft, account for a whopping 25% of the NASDAQ Composite. Technology accounts for 55% of the index.
The importance to you the investor
Simply put, the Dow isn’t as exposed to technology as the S&P 500 and NASDAQ. While we’ve experienced quite a run-up in tech this year, since June, the rally has broadened, which is healthy.
As we move forward, much will depend on interest rates and economic growth, though let’s not discount that unexpected events could influence shares, too.
The recent moderation in the rate of inflation has taken some pressure off the Federal Reserve.
Economic activity is also an important component, as most large companies are dependent on consumer or business spending for profit growth.
Longer term, we advise a diversified approach. Loading up on one sector may bring impressive short-term gains. But as we saw last year, it can also exacerbate losses. In 2022, the NASDAQ shed 33%, while the Dow lost just under 10% (MarketWatch data).
I trust you have found this review to be informative. If you have any inquiries or wish to discuss any concerns, please don’t hesitate to reach out.