Introduction to US Stock Market Indices

 it is important to spend some time understanding the way the markets work there and factors that influence them. An essential aspect of understanding the equity market of any country is the list of stock market indices. They act like a measuring gauge that offers a comprehensive view of the market conditions in the country. They can help you identify market trends and investor sentiment without getting into individual social, political, and other macroeconomic factors. Today, we will talk about stock market indices in the US and share some essential information about them.

The US stock market is the largest in the world and one of the most evolved ones too. Before we talk about the stock market indices in the US, let’s look at some basics:

What is a Stock Market Index?

A stock market index is a hypothetical portfolio of stocks that represents a certain segment of the market. There are different ways in which an index is formed and calculated.

Primarily, indices use a weighted average calculation to arrive at their value. This weighted average can be based on price-weightage, market capitalization-weightage, etc.

If an index follows the price-weightage method, then a change in the price of holdings with the highest price will impact the index more than those with a lower price. On the other hand, if the index follows a market cap-weighting method, then price becomes irrelevant and the index is impacted primarily by changes in the price of stocks with higher market capitalizations.

In the US, there are over 5000 stock market indices. Yes, you read that right – 5000+ stock market indices. There is an index for almost any conceivable sector or segment of the economy and the market. Of these, some indices are followed by most investors regularly as they offer a clear picture of the overall performance of the US markets. These are:

S&P 500

Dow Jones Industrial Average

Nasdaq Composite

Wilshire 5000

If you try to watch the news about the US stock markets, you will come across these names regularly. This is because the media usually reports on the direction of these indices to highlight the performance of the equity markets in the US. As an investor, an index can work as a performance and asset allocation guide. It can also help you invest passively via mutual funds or exchange-traded funds (ETFs). Let’s take a detailed look at these indices:

S&P 500

The S&P 500 or the Standard and Poor’s 500 is a stock market index having 500 top companies in the US. It is a market capitalization-weighted index and offers a comprehensive view of the performance of large-cap stocks in the country. It is one of the most widely used indices in the US. While the committee that selects the stocks for the index focuses on market capitalization, it also includes factors like liquidity, trading history, float, financial viability, etc. If you look at the value of the index, it represents around 80% of the total US stock market. Hence, it can offer a good view of the performance of the overall market. The selection criteria include:

A market capitalization of more the $6.1 billion

The ratio of annual dollar value to float-adjusted market cap > 1

Stocks with a minimum monthly trading volume of 250,000 shares for the previous six months

A publicly listed company on a major exchange in the US

Doesn’t fall in the list of securities deemed ineligible by the committee

Some top names in the S&P 500 are:

Apple Inc. (AAPL) – 7.3%

Microsoft Corporation. (MSFT) – 5.9%

Amazon.com Inc. (AMZN) – 5.0%

Facebook Inc. (FB) – 2.4%

Alphabet Inc. Class A Shares (GOOGL) – 1.7%

Alphabet Inc. Class C Shares (GOOG) – 1.7%

Berkshire Hathaway Inc. (BRK.B) – 1.5%

Johnson & Johnson (JNJ) – 1.4%

Visa Inc. (V) – 1.2%

Procter & Gamble (PG) – 1.2%

Dow Jones Industrial Average (DJIA)

The Dow Jones Industrial Average is one of the most popular stock indices in the world. It consists of 30 companies that are the most prominent in the US. Unlike the S&P 500, the DJIA is a price-weighted index. Traditionally, the calculation of the DJIA index was simple – the total price per share of the stocks of all companies in the index was divided by the number of companies. However, with time, this calculation evolved to factor in many factors like spin-offs, splits in stocks, etc. 

While the DJIA represents around 25% of the US stock market (much lower than the 80% representation of the S&P 500), it is believed to be an excellent indicator of the entire market. Most seasoned investors look to the DJIA as a representation of the best blue-chip companies in the US. There are no specific rules for the selection of stocks to be included in the DJIA. In fact, the selection of stocks does not change regularly. The stocks are selected to cover a gamut of companies from industries like IT, healthcare, etc.

Here is an interesting trivia about DJIA:

‘The Dow Jones Industrial Average was created in 1896 and consisted of 12 companies. It was expanded to 30 companies in 1928’

The 30 companies in DJIA are:

3M

American Express

Amgen

Apple

Boeing

Caterpillar

Chevron

Cisco Systems

Coca-Cola

Dow-DuPont 

Goldman Sachs

Home Depot

Honeywell

IBM

Intel

Johnson & Johnson

JPMorgan Chase

McDonald’s

Merck

Microsoft

Nike

Procter & Gamble

Salesforce

Travelers Cos.

UnitedHealth Group

Verizon

Visa

Walgreens Boots Alliance

Walmart

Walt Disney

Nasdaq Composite

The Nasdaq Composite is one of the world’s major stock indices. This index tracks the performance of around 3000 stocks that are traded on the Nasdaq exchange. It is an excellent indicator of the performance of the technological sector and includes companies of all sizes. This is a market capitalization-weighted index and includes some companies that are not from the US too. The index primarily focuses on tech companies but includes stocks from other sectors like finance, transportation, etc. Most experienced investors believe that the Nasdaq Composite Index is a great indicator of the performance of the tech sector and the investor sentiment towards this sector.

For a security to be included in the index, it needs to be listed on the Nasdaq stock market and must be:

An American Depository Receipt (ADR)

Common Stock

Ordinary Shares

Tracking Stocks

REITs or Real Estate Investment Trusts

Shares of Beneficial Interest

Limited Partnership Interests

There is a list of securities that are excluded from the index that includes exchange-traded funds (ETFs), convertible debentures, closed-ended funds, etc. Also, if security no longer meets the criteria, it is excluded from the index.

As of March 2020, the composition of the index was as follows:

Technology – 48.39%

Consumer Services – 19.43%

Healthcare – 10.21%

Finance – 7.21%

Industrials – 6.85%

Consumer goods – 5.51%

Utilities – 0.81%

Telecommunications – 0.72%

Oil and Gas – 0.55%

Basis materials – 0.32%

The top companies in the Nasdaq Composite Index are:

Microsoft

Apple

Amazon

Alphabet Class C

Alphabet Class A

Facebook

Intel

Netflix

PepsiCo

Cisco Systems

The Wilshire 5000 Total market index (TMWX)

The Wilshire 5000 Index is also known as the ‘total market index’. This index includes all the publicly listed companies in the US and has readily available data about their price. This index was created in 1974 and reflects the movement of the entire market. Companies need to fulfill the following criteria to be included in the index:

They must have headquarters in the US

The stocks of these companies must be listed and actively traded in the US

The pricing information of the stocks must be available to the public

The TMWX is the best single measure of the US stock market.

Here is an interesting trivia about Nasdaq Composite Index:

‘When the TMWX was launched in 1974, it contained 5000 stocks. In 2023, this number has dropped to 3451 stocks.’

Summing Up

As you can see, the top three stock indices are based on different stock pools and vary in size too. Hence, it is important to ensure that you spend some time in understanding these indices before making an investment in the US markets.

History

The beginnings of the stock exchange were in Italy in the late Middle Ages. In the 1300s, Venetian lenders would carry slates with information on the various issues for sale and meet with clients, much like a broker does today. [4] The Real Merchants of Venice introduced the principle of exchanging debts between moneylenders; a lender looking to unload a high-risk, high-interest loan might exchange it for a different loan with another lender. These lenders also bought government debt issues.[5] As the natural evolution of their business continued, the lenders began to sell debt issues to the first individual investors.2 The Venetians were the leaders in the field and the first to start trading securities from other governments.3 There is little consensus among scholars as to when corporate stock was first traded. Some view the key event as the Dutch East India Company's founding in 1602,[6] while others point to much earlier developments (Bruges, Antwerp in 1531 and in Lyon in 1548). The first book in history of securities exchange, the Confusion of Confusions, was written by the Dutch-Jewish trader Joseph de la Vega and the Amsterdam Stock Exchange is often considered the oldest “modern” securities market in the world.[7] On the other hand, economist Ulrike Malmendier of the University of California at Berkeley argues that a share market existed as far back as ancient Rome, that derives from Etruscan "Argentari". In the Roman Republic, which existed for centuries before the Empire was founded, there were societates publicanorum, organizations of contractors or leaseholders who performed temple-building and other services for the government. One such service was the feeding of geese on the Capitoline Hill as a reward to the birds after their honking warned of a Gallic invasion in 390 B.C. Participants in such organizations had partes or shares, a concept mentioned various times by the statesman and orator Cicero. In one speech, Cicero mentions "shares that had a very high price at the time". Such evidence, in Malmendier's view, suggests the instruments were tradable, with fluctuating values based on an organization's success. The societas declined into obscurity in the time of the emperors, as most of their services were taken over by direct agents of the state.

Tradable bonds as a commonly used type of security were a more recent innovation, spearheaded by the Italian city-states of the late medieval and early Renaissance periods.

Joseph de la Vega, also known as Joseph Penso de la Vega and by other variations of his name, was an Amsterdam trader from a Spanish Jewish family and a prolific writer as well as a successful businessman in 17th-century Amsterdam. His 1688 book Confusion of Confusions[9] explained the workings of the city's stock market. It was the earliest book about stock trading and inner workings of a stock market, taking the form of a dialogue between a merchant, a shareholder and a philosopher, the book described a market that was sophisticated but also prone to excesses, and de la Vega offered advice to his readers on such topics as the unpredictability of market shifts and the importance of patience in investment.

In England, King William III sought to modernize the kingdom's finances to pay for its wars, and thus the first government bonds were issued in 1693 and the Bank of England was set up the following year. Soon thereafter, English joint-stock companies began going public.

London's first stockbrokers, however, were barred from the old commercial center known as the Royal Exchange, reportedly because of their rude manners. Instead, the new trade was conducted from coffee houses along Exchange Alley. By 1698, a broker named John Castaing, operating out of Jonathan's Coffee House, was posting regular lists of stock and commodity prices. Those lists mark the beginning of the London Stock Exchange.[10]

One of history's greatest financial bubbles occurred around 1720. At the center of it were the South Sea Company, set up in 1711 to conduct English trade with South America, and the Mississippi Company, focused on commerce with France's Louisiana colony and touted by transplanted Scottish financier John Law, who was acting in effect as France's central banker. Investors snapped up shares in both, and whatever else was available. In 1720, at the height of the mania, there was even an offering of "a company for carrying out an undertaking of great advantage, but nobody to know what it is".

By the end of that same year, share prices had started collapsing, as it became clear that expectations of imminent wealth from the Americas were overblown. In London, Parliament passed the Bubble Act, which stated that only royally chartered companies could issue public shares. In Paris, Law was stripped of office and fled the country. Stock trading was more limited and subdued in subsequent decades. Yet the market survived, and by the 1790s shares were being traded in the young United States. On May 17, 1792, the New York Stock Exchange opened under a Platanus occidentalis (buttonwood tree) in New York City, as 24 stockbrokers signed the Buttonwood Agreement, agreeing to trade five securities under that buttonwood tree.