Define the "stock market.” What would initially seem easy becomes more complicated as we consider the various ways stocks are categorized: domestic versus international, large versus mid or small, value versus core or growth. Variations of these broad categories abound, leading to the creation of all kinds of indexes that are used to measure the performance of passive strategies versus active strategies. Globally, there are more stock indexes than actual company stocks. The proliferation of strategies that mirror these indexes has resulted in the amount of money invested in passive funds exceeding investments in actively managed funds. There is nothing "bad" or "good" about this trend, but it does highlight the fact that “invested passively” can mean many different things. And the performance between indexes and the funds which mirror them can differ dramatically.
Domestic stocks are defined by several indexes , but the most common are the Dow Jones Industrial Average (DOW), the S&P 500 and the NASDAQ. All have a large cap bias but significant differences in the number of stocks- 30, 500, and around 2500, respectively. There are also differences in how they measure performance. The DOW is a price-weighted index, which means movements in higher-priced stocks have a bigger impact on index performance. At the same time, the S&P 500 and the NASDAQ are capital-weighted indexes, which means the larger companies by market cap have a bigger, but not stable, influence on index performance. Lastly, there are some differences in the number and types of companies within the indexes. All three strive to represent a diversified reflection of the U.S. economy, but clearly, that is harder with only 30 stocks in the DOW, and the NASDAQ tends to be more heavily weighted towards technology stocks. For many, the most applicable representation of U.S. large cap stocks is the S&P 500.
This week's chart shows the index's performance as it is constructed, capital weighted where the largest companies have more influence, versus an equal weighted version where all companies carry the same influence. We do this to see how broad performance is across the index constituents. When the lines are close together it indicates that performance across sectors and companies is relatively similar. It is not surprising to see periods where the capital-weighted line is above the equal-weighted line as it makes sense to see well-managed profitable companies grow faster and become larger, which increases their index influence. However, one does not have to be an “expert chart reader" to see that the spread between these two measures has widened dramatically as we have moved through 2023 to today. As this has occurred the performance of the "index" has been heavily influenced by a smaller number of companies (think the Mag 7). It is hard to say how this spread might resolve itself going forward, but our preference would be for the broader market to begin to perform better, as opposed to the narrow number of leading stocks to decline.
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