General Introduction to U.S. Stock Market Indexes
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Stock market indexes
around the world are powerful indicators for global and country-specific
economies. In the United States the S&P 500, Dow Jones Industrial Average,
and Nasdaq Composite are the three most broadly followed indexes by both the
media and investors. In addition to these three indexes there are aproximetly 5000 index , that make up the U.S. equity market.
With so many indexes,
the U.S. market has a wide range of methodologies and categorizations that can
serve a broad range of purposes. The media most often reports on the direction
of the top three indexes regularly throughout the day with key news items
serving as contributors and detractors. Investment managers use indexes as
benchmarks for performance reporting. Meanwhile, investors of all types use
indexes as performance proxies and allocation guides. Indexes also form the
basis for passive index investing often done primarily through exchange-traded
funds that track indexes specifically.
Overall, an
understanding of how market indexes are constructed and utilized can help to
add meaning and clarity for a wide variety of investing avenues. Below we
elaborate on the three most followed U.S. indexes, the Wilshire 5000 which
includes all the stocks across the entire U.S. stock market, and a roundup of
some of the other most notable indexes.
KEY TAKEAWAYS
- There are approximately 5,000
U.S. indexes.
- The three most widely followed
indexes in the U.S. are the S&P 500, Dow Jones Industrial Average, and
Nasdaq Composite.
- The Wilshire 5000 includes all
the stocks from the U.S. stock market.
- Indexes
can be constructed in a wide variety of ways but they are commonly
identified generally by capitalization and sector segregation.
The S&P 500
The standard and
poor Index (known commonly as the
S&P 500) is an index with 500 of the top companies in the U.S. Stocks are
chosen for the index primarily by capitalization but the constituent committee
also considers other factors including liquidity, public float, sector
classification, financial viability, and trading history. The S&P 500 Index
represents approximately 80% of the total value of the U.S. stock market. In
general, the S&P 500 Index gives a good indication of movement in the U.S.
market as a whole.
Indexes are usually
market weighted or price weighted. The S&P 500 Index is a market weighted
index (also referred to as capitalization weighted). Therefore, every
stock in the index is represented in proportion to its total market capitalization
. In other words, if the total market value of all 500 companies in the S&P
500 drops by 10%, the value of the index also drops by 10%.
The Dow Jones Industrial Average
The Dow jones industrial average (DJIA) is one
of the oldest, most well-known, and most frequently used indexes in the world.
It includes the stocks of 30 of the largest and most influential companies in
the United States. The DJIA is a price-weighted index. It was originally
computed by totaling the per-share price of the stocks of each company in the index
and dividing this sum by the number of companies. Unfortunately, the index is
no longer this simple to calculate. Over the years, stock splits, spin-offs,
and other events have resulted in changes in the divisor (a numerical value computed by Dow Jones used
to calculate the level of the DJIA) making it a very small number (less
than 0.2).
The DJIA represents
about a quarter of the value of the entire U.S. stock market, but a percent change
in the Dow should not be interpreted as a definite indication that the entire
market has dropped by the same percent. This is because of the Dow's
price-weighted function. The basic problem is that a $1 change in the price of
a $120 stock in the index will have a greater effect on the DJIA than a $1
change in the price of a $20 stock, although the higher-priced stock may have
changed by only 0.8% and the other by 5%.
A change in the Dow
represents changes in investors' expectations of the earnings and risks of the
large companies included in the index. Because the general attitude toward
large-cap stocks often differs from the attitude toward small-cap stocks,
international stocks, or technology stocks, the Dow should not be used to
represent sentiment in other areas of the marketplace. In general, the Dow is
known for its listing of the U.S. markets best blue-chip companies with
regularly consistent dividends. Therefore, while not necessarily a
representation of the broad market, it can be a representation of the
blue-chip, dividend-value market.
The Nasdaq Composite Index
Most investors know
that the Nasdaq is the exchange on which technology stocks are traded.
The Nasdaq composite index is a market-capitalization-weighted index
of all the stocks traded on the Nasdaq stock exchange. This index includes some
companies that are not based in the United States.
Known for being
heavily tech weighted, this index includes several subsectors across the tech
market including software, biotech, semiconductors, and more. Although this
index is known for its large portion of technology stocks, it does include some
securities from other industries as well. Investors will also find securities
from a variety of sectors as well, including financials, industrials,
insurance, and transportation stocks, among others. The Nasdaq Composite
includes large and small firms, but unlike the Dow and the S&P 500, it also
includes many speculative companys with
small market capitalizations. Consequently, its movement generally indicates
the performance of the technology industry as well as investors' attitudes
toward more speculative stocks.
The Wilshire 5000
THe Willshire 5000 is sometimes
called the "total stock market index" or "total market
index" because it includes all of the publicly traded companies with
headquarters in the United States that have readily available price data.
Finalized in 1974, this index represents the entire U.S. stock market and its
movement aggregately. Although it is a very comprehensive measure of the entire
U.S. market, the Wilshire 5000 is referred to less often than the more popular
S&P 500 Index.
A Roundup of Other U.S. Indexes
Generally, there are a
few ways to look at indexes broadly. Capitalization is often key, with indexes
falling into either large-, mid-, or small-cap buckets. The S&P 500 and Dow
Jones Industrial Average are two of the top large-cap indexes, but others
include the S&P 100, the Dow Jones U.S. Large-Cap Total Stock Market Index,
the MSCI USA Large-Cap Index, and the Russell 1000. Notable index mid cap include the S&P Mid-Cap 400, the
Russell Midcap, and the Wilshire US Mid-Cap Index. In small-caps, the Russell
2000 is an index of the 2,000 smallest stocks from the Russell 3000. Other
popular small-cap indexes include the S&P 600, the Dow Jones Small-Cap
Growth Total Stock Market Index, and the Dow Jones Small-Cap Value Total Stock
Market Index.
Investors also
commonly look to sectors with Standard & Poor’s leading in this realm of
the market. Standard & Poor’s manages: the S&P Communication Services
Select Sector, S&P Consumer Discretionary Select Sector, S&P Consumer
Staples Select Sector, S&P Energy Select Sector, S&P Financial
Select Sector, S&P Health Care Select Sector, S&P Industrial Select
Sector, S&P Materials Select Sector, S&P Real Estate Select
Sector, S&P Technology Select Sector, and the S&P Utilities Select
Sector. These indexes represent the S&P 500’s comprehensive sector
segregations.
The growth of smart
beta index investing has also helped to increase the number of indexes in the
market. Smart beta indexes are passive indexes that are built using certain
characteristic or fundamental screens that help to improve the quality of index
constitution. Advisors Asset Management (AAM) has three smart beta index funds
in the market that largely encompass the entire global market for dividend and
value investing. AAM’s smart beta index funds include the AAM S&P 500 High
Dividend Value ETF (SPDV), the AAM S&P Developed Markets High Dividend
Value ETF (DMDV), and the AAM S&P Emerging Markets High Dividend Value ETF
(EEMD).
The Bottom Line
Indexes play an important
part in the overall analysis of the U.S. equity market. Indexes and their
movements provide a great deal of insight into the economy, the investing
public’s risk appetite, and the trends for investing diversification. In
general, understanding the nuances of their construction and composition can be
essential for making all types of investment decisions.
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