Bonus Material: Investing Tips
On Thursday, July 11, 2019, two of the major market indices hit historical record highs. For the first time, the Dow closed over 27,000. The S&P 500 also hit a record closing at almost 3,000. However, the Nasdaq composite fell 6.49 points, or 0.08%, to 8,196.04.
Should investors care?
Maybe. Over the last 123 years since its inception, the Dow has become a significant indicator of the U.S. economy. When the news reports stock market movements, it is usually referencing the Dow. The Dow is arguably the most watched stock index in the world. Initially, the Dow was an index focused solely on industrials. Now, the Dow covers 30 well-established, high investment quality companies in multiple industries. Dow has had 52 changes since inception to keep in line with the progression of the economy. In June 2018, Walgreens Boots Alliance, Walgreens (NASDAQ: WBA), gave General Electric (NYSE: GE) the “boot” from the Dow. Four years ago, Apple replaced dividend aristocrat, AT&T (NYSE: T).
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The Standard and Poor’s 500 (“S&P 500”) tracks the 500 of the largest companies. As an important note, T-Mobile (NASDAQ: TMUS) will replace Red Hat Inc. in the S&P 500 starting Monday, July 15. IBM (NYSE: IBM)acquired Red Hat in a deal that closed Friday, July 12, 2019, and is no longer listed.
The Nasdaq Composite Index is an index of over 3,300 stocks traded on the Nasdaq stock exchange. Not surprisingly, there is significant overlap between all three of the indices. But for anyone who’s been paying attention, the market leaders of this recent surge are clear. Apple (NASDAQ: APPL) and Microsoft (NASDAQ: MSFT) are a component of all three indices—the Dow, S&P 500, Nasdaq composite. Both the Dow and the S&P 500 include Visa (NYSE: V). Amazon (NASDAQ: AMZN) and Alphabet (NASDAQ: GOOG), two-fifths of the FAANG stocks, are part of the S&P 500 and Nasdaq composite.
All these gains… so what happened to your portfolio?
If your portfolio did not perform as well as you expected on Thursday, it’s important to remember the indices are “averages.” Even if you own some of the stocks represented, your portfolio will not reflect the indices’ performance. For example, with Thursday’s record high, some of the Dow’s most well-known companies- Apple, Johnson & Johnson (NYSE: JNJ), Merck (NYSE: MRK) - were down.
Second, which is a more nuanced point, the indices are weighted differently, which significantly affects its performance. The Dow is a price-weighted index meaning that higher priced stock will have more influence over the movement of the index than a lower priced stock. On the other hand, market capitalization (“market cap”) is used to calculate the weights of the Nasdaq Composite and the S&P 500. As a result, the movements of a stock with a higher market value, or market capitalization, will affect the index more than a company with a higher price per share.
Microsoft and Visa provide a great example of the difference. Both companies are listed in the Dow and the S&P 500, but the respective indexes give each company a different weight. Because Visa has a higher price than Microsoft, it has more influence over the Dow. But Visa’s market capitalization is approximately 40% of Microsoft’s, Microsoft has a significantly higher impact on the S&P 500.
Is there something lurking in the market?
The question many aren’t asking but should be, is this milestone more of an indication of a market slow down? This 1,000 point increase from 26,000 to 27,000 took almost 39 times longer, 17 months, than the Dow’s movement from 25,000 to 26,000, which took only two weeks. It’s been a bumpy ride. Is this a function of the market just ignoring “all the scary headlines” or irrational exuberance fueled by overvalued tech unicorns much like what caused the dot.com bubble burst of the early 2000s? I would contend that it’s the latter, and investors should be cautious.
Investments that track the indices
If you want to get performance closer to the index, you might want to look into indices that seek to follow them directly. Remember, the key is to buy low and sell high. Consider holding off on purchasing indexes because they are still at record highs. SPDR’s exchange-traded fund (ETF), DIA, tracks the Dow. Fortunately, or unfortunately, there’s no shortage of ETFs which track the S&P 500 including SPDR (SPY), iShares (IVV), and Vanguard (VOO). The ETF that tracks the Nasdaq Composite is Fidelity Nasdaq Composite Index Tracking ETF ONEQ. Note that several ETFs cover only Nasdaq’s top 100 including Invesco’s QQQ.