A stock market index is an indicator of an economy’s performance. It indicates the health of an economy by tracking the performance of the companies in the market. There are approximately 5,000 indices in the U.S., and this article covers a few of the most followed indices like the S&P 500, Dow Jones Industrial Average, and Nasdaq Composite Index.
US Stock Market – An Overview
The stock market in the U.S. first started in the late 1700s when a group of merchants got together to buy and sell shares and bonds. They made the Buttonwood Tree Agreement which is the basis of the New York Stock Exchange (NYSE), the largest stock exchange in America. However, the first stock exchange in the U.S. was the Philadelphia Stock Exchange, established in 1790. For almost two centuries, these two were the major stock exchanges in the U.S., until trading began on NASDAQ in 1972.
Over the years, more market indices were created, and stock market trading moved from physical format to computerised format. The stock market evolves continuously over the next few decades, and it took centuries to create the current modern-day market. Though trading started off with shares and bonds, multiple other financial instruments also trade on the U.S. stock market today.
US Stock Market Indices
The total market capitalisation of the U.S. stock market is close to $ 49,107,685.7 million as of 31st March 2021. Over a period of 100 years, the U.S. stock market capitalisation increased by 200%. The U.S. stock market has approximately 5,000 stock market indices. The major stock market indices are S&P 500, Dow Jones Industrial Average, and Nasdaq Composite Index. Each of the indices uses various methodologies and categorisations for listing stocks on the index.
The S&P 500 is a market-cap-weighted index. Stocks with larger market capitalisation have a greater influence on the movement on the index. The Dow Jones Industrial Average uses a price-weighted average as the basis of the index. Stocks with higher prices have more impact on the index movement. Nasdaq also uses a market capitalisation weighting methodology.
The US Stocks market has various financial instruments other than shares and bonds. Currencies, mutual funds, equity options, futures, REITs, sovereign debt securities, and asset-backed securities are also traded on stock exchanges.
The Standard and Poor’s 500 Index is a U.S. stock market index that tracks the top 500 companies in the U.S. It is a widely used index and often considered as a gauge for the large-cap companies in the country. The index follows the market capitalisation-weighted method and picks the top 500 companies for the index. However, market capitalisation is not the only criteria to pick stocks for the index.
The S & P 500 was introduced in the year 1957 by Standard & Poor. It uses free-float weighted market capitalisation as the basis to calculate the value of the index. The total number of outstanding shares is times the market price of the share to determines a company’s market cap. The company with higher market capitalisation is given higher weightage than the company with lower market capitalisation.
A committee is appointed to select stocks based on industry, liquidity, and size. The index is rebalanced every March, June, September, and December. To qualify for the S & P 500, the company must be present in the USA, and it must have an unadjusted market capitalisation of at least $8.2 billion. Also, 50% of the shares must be available to the public for trading, and the share price of the company should be at least $1. Moreover, 50% of the fixed assets and revenue should be in the U.S. It must also have four consecutive quarters of positive earnings. Shares, debentures, bonds, mutual funds, REITs, equity derivatives like options, and futures all trade on S&P 500.
Nasdaq Composite Index
Nasdaq exchange is popular for trading technology stocks. The Nasdaq Composite Index comprises more than 2,500 common equities listed on the Nasdaq stock exchange. The index uses market capitalisation weighting methodology. In other words, the index’s value is equal to the total value of the share weights of each security multiplied by the security’s last trading price.
Nasdaq composite index comprises of the following types of securities:
- Common Stocks
- American Depositary Receipts
- Real Estate Investment Trusts (REITs)
- Tracking Stocks
- Limited Partnership Interest
In other words, the index comprises all the Nasdaq listed stocks except derivatives, funds, ETFs, preferred shares, or debentures. Furthermore, this index includes some companies that are based outside of the United States.
Known for having more tech stocks, the index includes sub sectors such as semiconductors, software, biotech, etc. It also has securities that are part of other industries, for example, financial, transportation, insurance, industrial, etc.
The Nasdaq Composite Index primarily includes large and small-cap companies. Unlike Dow and the S&P 500, this index also includes speculative companies that have small market capitalisation. As a result, the index’s movement often indicates the tech industry’s performance and the investor’s attitude towards speculative stocks.
The Wilshire 5000 is also known as the ‘total stock market index or ‘ total market index’. The index includes all the publicly traded companies that have their headquarters in the United States. Therefore, the index represents the entire U.S. stock market and its movement.
Wilshire maintains the following three versions of the index:
- Fully market-cap-weighted
- Float adjusted
- Equal weighted
Though the Wilshire 5000 is a comprehensive index, it is often less referred to than the more popular S&P 500.
Dow Jones Industrial Average
The Dow Jones Industrial Average (DJIA) is among the oldest, well-known, and most frequently used indexes in the world. The index includes 30 stocks of the largest and most influential companies in the USA.
Dow Jones Industrial Average is a price-weighted index. Earlier, the price computation was easy. It was the total per-share price of the stocks of each company divided by the number of companies. With stock splits, spin-offs, etc., the computation is no longer simple.
The DJIA accounts for around a quarter of the total value of the U.S. stock market. However, the movement in the Dow should not be regarded as a guarantee that the entire market has declined by the same percentage.
A change in the Dow can imply the changes in the investor’s expectations of the earnings of the large companies. Dow is known for its blue-chip companies that give regular and consistent dividends. Hence, it can be a representation of the blue-chip dividend value market.
Other US Stock Market Indexes
Capitalisation is often the key for index classification – small, mid, large-cap.
Following are the two popular large-cap indexes:
- S&P 500
- Dow Jones Industrial Average
- For mid-cap, the following are some of the notable indexes:
- S&P Mid-Cap 400
- Russell Midcap
- Wilshire US Mid-Cap Index
Following are popular small-cap indexes:
- Russell 2000
- S&P 600
- Dow Jones Small-Cap Growth Total Stock Market Index
- Dow Jones Small-Cap Value Total Stock Market Index
Furthermore, sector-based classification is another popular index classification. These indexes represent the S&P 500’s comprehensive sector segregations. Following are the leading S&P sector-based indexes:
- Financial Select Sector (XLF)
- Health Care Select Sector (XLV)
- Real Estate Select Sector (XLRE)
- Technology Select Sector (XLK)
- Energy Select Sector (XLE)
- Industrial Select Sector (XLI)
- Consumer Staples Select Sector (XLP)
- Utilities Select Sector (XLU)
- Materials Select Sector (XLB)
- Communication Services Select Sector (XLC)
- Consumer Discretionary Select Sector (XLY)
Also, there are Smart Beta Indexes that are passive indexes built using certain characteristics or fundamental screens. These help to improve the quality of the index constitution. The three smart beta index funds under the Advisors Asset Management (AAM) are:
- AAM S&P 500 High Dividend Value ETF (SPDV)
- AAM S&P Emerging Markets High Dividend Value ETF (EEMD)
- Advisors Asset Management S&P Developed Markets High Dividend Value ETF (DMDV)
These three smart beta index funds encompass the entire global market for dividend and value investing.