Q3 2018 Market and Economic Commentary is now available! This commentary touches on the following:…
Q3 2019 Client Question of the Month: How’s the market doing?Client Questions |
by Andrew Murphy, CFA Director of Portfolio Management
We’ve received a few questions over the last several weeks on the differences between major US indices. The answer to, “how’s the market doing?”, can sometimes depend on the index used. According to the Index Industry Association, there are over 3.3 million indices compiled by 14 different companies. The Financial Times found that on a worldwide basis there are over 70 times more stock indices than there are individual stocks. In our client question of the month we will examine the differences between the three most widely referenced US indices, the S&P 500, the Dow Jones Industrial Average (Dow), and the Russell 3000.
Let’s get into the details on the history, structure, methodology, and differences between each index.
History and Structure
S&P 500: The origin of the S&P 500 goes back to 1923, when Standard & Poor’s introduced a series of indices that included 233 companies and covered 26 industries. The S&P 500 in its current form was introduced in 1957. The S&P 500 is the only stock market benchmark serving as an economic indicator in The Conference Board Leading Economic Index.
The S&P 500 is widely regarded as the best single gauge of large-cap US equities. Over $6.5 trillion in active funds and $3.4 trillion in passive funds utilize the S&P 500 as a benchmark. The index covers approximately 80% of the investable US equity market. Source: S&P Dow Jones Indices.
The Dow: Charles Dow founded the Dow Jones Industrial Average on May 26, 1896. The Dow was initially comprised of 12 stocks (versus 30 today), including a leather maker, a steel provider, and a sugar producer. According to S&P Dow Jones Indices, the Dow rose to prominence during the stock market crash of 1929 when investors began monitoring the index as a representation for the overall market.
The Dow is a price-weighted index of 30 US blue-chip companies. The index covers approximately 25% of the investable US equity market. The index provides suitable sector representation except for the transportation industry and utilities sector. Source: S&P Dow Jones Indices.
Russell 3000: The Russell US indices were created in 1984 by the Frank Russell Company with the goal of providing accurate representation of the investable US equity market. The Russell indices are designed to provide performance benchmarks for active strategies, as the underlying basis for passive investment products, and as a proxy for US equities in asset allocation decisions.
The Russell 3000 is designed to gauge the entire US stock market. Over $6 trillion in active funds and $1 trillion in passive funds utilize a Russell index as a benchmark. The Russell 3000 index covers approximately 98% of the investable US equity market. Covering the entire US market would require purchasing several thousand small or potentially illiquid companies. Source: FTSE Russell.
How are index weights calculated?
Dow Jones Industrial Average: Price Weighted
In a price-weighted index, the weight of each security is determined by its share price. A stock with a higher share price will have a greater weight and more impact on the index performance than a lower price one. To start, a price weighted index assumes that each security is held in the same quantity. Next, an adjustable divisor accounts for actions that impact the shares outstanding, including, price adjustments, special dividends, stock splits, rights offerings, additions, and/or deletions.
S&P 500 and Russell 3000: Float Adjusted Market Cap Weighted
In a float adjusted market cap index, the weight of each security is determined by its market capitalization (= share price X public shares outstanding). Larger market cap stocks will have a greater weight and more impact on the index performance than smaller ones. Float-adjusted means that the total shares outstanding for each security only includes those that are held by the public and are available for trading. Restricted shares or strategic holdings are not included.
What are the differences between each index?
The difference between each index is probably best illustrated with the following chart. Note that the S&P 500 and Russell 3000 are similar while the Dow Jones Industrial Average is unique. We believe it is important to understand the differences across methodology, holdings, market caps, sectors, and returns when answering the “how’s the market doing?” question or using an index as a benchmark. We will usually reference the S&P as a proxy for the US market since it is the most well-known index, but we prefer the Russell 3000 as a benchmark since it covers most of the investable market by including mid and small cap stocks. At Winthrop Wealth Management, our US equity portfolios most closely resemble the Russell 3000 due to the potential return and diversification benefits of investing in mid and small cap stocks.
As a quick side note, we notice that references to the Dow mostly occur during periods of market volatility. The price of the Dow is much larger than either the S&P 500 or Russell 3000. As of month end, the price of the Dow was at 26,917, the S&P 500 at 2,977, and the Russell 3000 at 1,743. Note that the price of the index is used to calculate performance and does not reflect the value or total market capitalization of the underlying holdings. While the Dow has the highest price of the three indices, it covers the least amount of the investable US market. We will use the following market drop in August as an example:
Anecdotally, we received several more questions referencing the decline in the Dow even though each index was down about -3%. Why? Moves in the Dow just sound more dramatic. The Wall Street Journal headline of “Dow Sheds 800 in Biggest Drop of Year” sounds more severe than “S&P Drops 86” or “Russell 3000 Declines 50”. Keep in mind that financial newspapers or televisions stations get paid for readers and viewers, not necessarily for providing sound investment advice. While we monitor the Dow as one of several indices, we notice that others usually bring it up only in reference to large price swings.
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The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.
Investing involves risk including loss pf principal.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.
The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
All indexes mentioned are unmanaged indexes which cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. Past performance is no guarantee of future results.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The S&P Midcap 400 Stock Index is an unmanaged index generally representative of the market for the stocks of mid-sized US companies.
The Russell 2000 Index is an unmanaged index generally representative of the 2,000 smallest companies in the Russell 3000 index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index.
The prices of small cap stocks and mid cap stocks are generally more volatile than large cap stocks.
The Russell 1000 Growth Index measures the performance of those Russell 1000 companies with higher price-to-book ratios and higher forecasted growth values.
Russell 1000 Value Index measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values.
The Bloomberg Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
The Barclays Capital U.S. Credit Bond Index measures the performance of investment grade corporate debt and agency bonds that are dollar denominated and have a remaining maturity of greater than one year.
The Barclays Capital Municipal Bond Index is a broad market performance benchmark for the tax-exempt bond market, the bonds included in this index must have a minimum credit rating of at least Baa.DISCLOSURES
The Barclays Capital US Corporate High Yield Bond index is an index representative of the universe of fixed-rate, non-investment grade debt
The MSCI EAFE Index is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI EAFE Index consists of the following developed country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the UK.
The MSCI Europe Index captures large and mid cap representation across 15 Developed Markets (DM) countries in Europe*. With 445 constituents, the index covers approximately 85% of the free float-adjusted market capitalization across the European Developed Markets equity universe.
The MSCI Japan Index is designed to measure the performance of the large and mid cap segments of the Japanese market. With 322 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in Japan.
The MSCI India Index is designed to measure the performance of the large and mid cap segments of the Indian market. With 78 constituents, the index covers approximately 85% of the Indian equity universe.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The MSCI EM Index consists of the following emerging market country indices: Brazil, Chile, Colombia, Mexico, Peru, Czech Republic, Egypt, Greece, Hungary, Poland, Qatar, Russia, South Africa. Turkey, United Arab Emirates, China, India, Indonesia, Korea, Malaysia, Philippines, Taiwan, and Thailand.
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
The Russell 3000 Growth Index is an unmanaged index comprised of those Russell 3000 companies with higher price-to-book ratios and higher forecasted growth values. The Russell 3000 Value Index measures the performance of those Russell 3000 companies with lower price-to-book ratios and lower forecasted growth values.
The MSCI China Index is constructed based on the integrated China equity universe included in the MSCI Emerging Markets Index, providing a standardized definition of the China equity opportunity set. The index aims to represent the performance of large- and mid-cap segments with H shares, B shares, red chips, P chips and foreign listings (e.g., ADRs) of Chinese stocks. China A shares will be partially included in this index, making it the de facto index for all of China. It can be used as a China benchmark for investors who use the MSCI ACWI Index or MSCI EM Index as their policy benchmark.
The MSCI ACWI ex USA Index captures large and mid cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 26 Emerging Markets (EM) countries*. With 2,206 constituents, the index covers approximately 85% of the global equity opportunity set outside the US.
The MSCI United Kingdom Index is designed to measure the performance of the large and mid cap segments of the UK market. With 97 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in the UK
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