How’s the market doing lately?
If you look for the answer on the CNBC homepage or during breaks on news radio, you’ll get three different numbers: the performance of the S&P 500, Dow Jones Industrial Average and Nasdaq Composite.
All three “headline indexes” are considered, in one way or another, proxies for the stock market, and over long periods, they’ve tended to perform pretty similarly.
Over the past 15 years, the S&P and Dow have moved in the same direction 94% of the time, according to CNBC’s calculations. Over the same period, the S&P and Nasdaq have moved in lockstep 92% of the time.
Things look wildly different as of late, however. So far in 2023, the Nasdaq has outshone the other indexes, returning just north of 34%. The S&P has logged about an 18% return, with the Dow bringing up the rear with a comparatively measly 6%.
To understand why these returns are so varied — and what that means — you first need to understand how each index works.
How the three major indexes are put together
Investors use different collections of stocks to represent the performance of the overall stock market, but each index is put together slightly differently, leading to divergences in short-term performance.
Here are the major three you’re likely to hear about, and the quirks that explain their differences.
S&P 500
When investing pros talk about market returns, they’re usually talking about the S&P 500. The index tracks roughly the 500 largest U.S.-traded stocks, comprising 80% of all stocks traded on the market.
Created in 1957, the index was the U.S.’s first index weighted by market capitalization (stock price times total outstanding shares), and today it is the favored benchmark index for mutual fund managers who measure themselves against the broad stock market.
Some $15.6 trillion in investor mutual fund and ETF assets are benchmarked to the index, according to S&P Global. As of 2021, $7.1 trillion belonged to funds and ETFs that directly track the S&P’s performance.
Admission in the index is generally based on a company’s size and other mathematical variables, but other criteria may come into play for the index committee, which ultimately decides which companies belong. Tesla, for instance, was temporarily denied entry despite meeting most fundamental criteria over questions about the sustainability of the company’s earnings.
Generally, though, thanks to its weighting criteria, the S&P tilts toward the largest companies. That means the S&P currently leans toward tech, which makes up just shy of 30% of the index.
Dow Jones Industrial Average
The Dow is very much your grandfather’s stock index. It debuted in 1896 and still carries some of the conventions of an index that existed before computers made stocks easy to track. It holds only 30 stocks chosen by a committee, which consists of three representatives from S&P Dow Jones Indices and two representatives from the Wall Street Journal.
Companies are added only if they’re deemed to have an excellent reputation, a history of sustained growth and interest among a large number of investors.
Another quirk of pre-computer investing is that, rather than weighing the stocks in the index by market cap, the top spots in the index go to the stocks with the highest share price. That means certain high-priced names can’t be included, as they’d have too big an impact on index performance.
Because of its focus on high-quality, dividend-paying firms (what some might call “blue chip” stocks), the Dow has tended to hold up better than the other indexes in down markets.
In 2022, for instance, the Dow lost only 7% compared with a nearly 19% loss in the S&P and a 32% slide in the Nasdaq. At 1.89%, the Dow’s average dividend yield is higher than that of the other two indexes.
Nasdaq Composite
The Nasdaq Composite includes all stocks listed on the Nasdaq Stock Market — the first electronic stock exchange. The more than 2,500 stocks in the index skew heavily toward stocks in the technology and communications sectors, which make up 48% and 14% of the index, respectively.
The Nasdaq is weighted by market cap, which means fast-growing tech giants tend to dominate. Apple and Microsoft alone account for a quarter of the index.
It’s easy to see, then, why the Nasdaq has posted eye-popping returns of late, as tech and communications stocks have been on a market-leading run. Each of its top five holdings — Apple, Microsoft, Alphabet, Amazon.com and Nvidia — have posted returns of more than 33% so far in 2023, with Nvidia logging a 218% gain.
Of course, that means the reverse is true when investors sell out of tech stocks. When the dotcom bubble popped, and the market slumped from 2000 to 2002, the Nasdaq shed 78% compared with a 49% drop in the S&P 500 and a 34% downdraft in the Dow.
Why the Nasdaq is trouncing the Dow in 2023
The Nasdaq’s outperformance and the Dow’s disappointing year come down to the indexes’ unique compositions, says Ryan Detrick, chief market strategist at the Carson Group.
“Clearly, the Dow doesn’t have as much exposure to communications and technology. The Nasdaq has benefitted from exposure to some of those names,” he says.
Indeed, large-company tech stocks are leading a hot stock market in 2023, having returned 44% on average so far this year. By comparison, large financial and health-care stocks — the two biggest sectors in the Dow — have returned an average 4.4% and 0.8% respectively.
To put an even finer point on it, UnitedHealth Group, which accounts for more than 9% of the Dow — the largest holding in the index — has sunk 2.3% on the year.
Whether the Dow eventually catches up to its counterparts depends on the shape of the next bull market. In a healthy bull run, says Detrick, market leadership tends to change as a rising tide lifts all boats.
“Tech had one of its best first six months ever. That’s an area we think could come back to Earth a little bit,” he says. “Things could broaden out into some other areas. The lifeblood of a bull market is passing that baton around.”
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