Understanding Market Indices
Following activity in the financial market can be complicated – the markets are subject to fluctuations in the short run and are influenced by long-term trends. Market indices are indicators of what has already happened in the market, but an understanding of them can be helpful to you in tracking and managing your investments.
Here’s an overview of the most recognizable indices:
The Dow Jones Industrial Average:
The Dow Jones Industrial Average (DJIA), also known as "the Dow", tracks the prices of 30 large-company U.S. stocks.
The Dow is over 100 years old, and the companies included in its index are chosen by the editors of the Wall Street Journal. As the U.S. Economy changes, the companies represented in the Dow are changed in response. Over time, as the economy has been increasingly fueled by service businesses and consumer products, companies such as McDonalds, and Wal-Mart have been added to the Dow.
Business reporters use the Dow Jones Industrial Average to give a quick, general indicator of market conditions. When you hear on the news that the Dow lost 8% of its value, it’s likely that other stock indices may have fallen as well.
The Dow Jones Utility Average and the Down Jones Transportation Average
In addition to services and consumer products the Dow also compiles the Dow Jones Utility Average and the Dow Jones Transportation Average.
Stocks within these two Averages are also chosen by the editors of the Wall Street Journal. The Dow Jones Utility Average follows 15 stocks, including American Electric Power Co., Dominion Resources, Exelon Corporation and Edison International.
There are 20 stocks in the Dow Jones Transportation Average, including Jet Blue, Ryder Systems, United Parcel Service, FedEx Corporation ,Continental Airlines, Southwest Airlines, and CSX Corporation.
Gross Domestic Product (GDP): Published quarterly by the Department of Commerce
The GDP is perhaps the greatest indicator of a country’s economic health. It represents the monetary value of all the goods and services produced by an economy including consumption, government purchases, investments, and the trade balance. The GDP indicates the pace at which an economy is growing. If it fails to meet or beat the market expectations, stock prices can decline.
The S&P 500 Officially called Standard & Poor’s Composite Index of 500 Stocks, the S&P 500 is another common benchmark focusing on large companies. It differs from the Dow in that it consists of 500 companies instead of just 30, and it is weighted according to the market values of the stocks it tracks.
For example, a company with a market value of $70 billion would carry 10 times the weight of a company with a market value of $7 billion. Since it is made up of many more companies, the S&P 500 gives you an overview of what has happened with the broader stock market, and includes utilities, transportation, financial, and industrial companies. Because it so broadly represents large U.S. businesses, the S&P 500 is the basis for index funds that seek to track the large-company market. Standard & Poor’s is a subsidiary of McGraw-Hill, Inc.
The Russell 1000
The Russell 1000 measures the performance of the 1,000 largest companies in the U.S. The components of the Russell 1000 Index account for about 90% of the equity traded on the U.S. exchanges.
The Index is market-cap weighted, meaning that the largest firms have the greatest impact on the Index’s returns. The Index’s components range in size from $1 billion to more than $300 billion (based on market cap), with the average firm carrying a market cap of around $80 billion.1
Compared with the Dow or the S&P 500, the selection of companies that make up this index is less subjective, because membership is based only on market value and not by a committee that decides which stocks to include. The Russell 1000 is compiled by The Frank Russell Company, an investment management and consulting company.
Some more specialized indices allow you to look at the stock market performance of particular industry groups or companies of a certain size.
The NASDAQ Composite
NASDAQ stands for "National Association of Securities Dealers Automated Quotation System." The NASDAQ Composite Index measures more than 5,000 U.S. and non-U.S. companies listed on the NASDAQ stock market.
The NASDAQ market also has indices for the following eight industry groups: banks, biotechnology, computers (software and hardware), industrial, insurance, other finance, telecommunications, and transportation.
NASDAQ-listed companies are primarily mid-size and are placed in the relevant industry index based on Standard Industrial Classification (SIC), a numerical code that categorizes companies within industries. The SIC system has been used in the U.S. for about 60 years by government statisticians who track the economy, and by banks reviewing financial data for companies within a common industry.
Because the NASDAQ lists primarily growth, technology, and financial companies, you can use the NASDAQ indices to get a handle on these dynamic markets.
The Russell 2000, S&P Mid Cap and Small Cap Indices
The Russell 2000 measures the performance of 2,000 Small Cap companies, defined as those with a median market value of $500 million. This index consists of the next 2,000 companies in size after the largest 1,000.
While smaller companies don’t account for a great deal of U.S. market capitalization (the market value of total stock) they are an important indicator of our economy’s ability to nurture new ideas and grow. Typically, small-company indices are more volatile than large-company indices, because the results and outlook of smaller companies fluctuate more.
Standard & Poor’s Mid Cap and Small Cap Indices
Two Standard & Poor’s indices also track smaller companies.
The S&P Mid Cap Index tracks the performance of 400 companies with a median market value of just under $2 billion.
The S&P Small Cap Index tracks 600 companies with a median market value of $460 million.
Keep in mind that you probably shouldn’t compare all your investments to the same index. If you’re investing in a Small Cap fund, be sure to compare its performance to a Small Cap index like the Russell 2000 or S&P Small Cap.
If you’re evaluating a technology fund, compare it to a technology index like the NASDAQ technology or even the overall NASDAQ index.
In addition to providing an overview of market and industry conditions, indices can also help you evaluate the performance of your investment fund manager. For instance, if your Mid Cap mutual fund is earning returns that exceed the S&P Mid Cap Index (after expenses and other fees are deducted) over time, you’ve probably chosen a strong manager. If your Large Cap growth and income fund consistently lags behind the S&P 500, it may be time to reevaluate your investment choices.
EURO STOXX 50® Index (EURO STOXX 50®) – An index of blue-chip stocks that are represented by 50 stocks covering the largest sector leaders in the EURO STOXX 50® Index. It does not reflect dividends payable on the underlying stocks.
Hang Seng Index – An index of the largest and most liquid stocks listed on the Stock Exchange of Hong Kong. It does not reflect dividends payable on the underlying stocks.
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You can find out more about the major market indices and how they work by logging on to the Securities and Exchange Commission’s website at www.sec.gov/index or by visiting the NASDAQ website at www.nasdaq.com.
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