The Parks Wealth Report
August 27, 2012
Close, but not quite.
Last week, the U.S stock market hit an intra-day four-year high, but it couldn’t hold the gain and closed slightly lower for the week, according to MarketWatch. As usual, news flow from Europe and the Federal Reserve helped move prices.
While we often look at the broad market indexes to gauge progress in the stock market, those indexes sometimes send misleading signals. One cause of the misleading signals is the way the indexes are calculated. For example, some indexes, like the Dow Jones Industrial Average, are calculated using the price of each stock. This means a stock with a high price (e.g., IBM) will have a larger influence on the index than a lower priced stock. By contrast, the S&P 500 index is a capitalization-weighted index. This means stocks with a large market value (like Apple) will have a larger influence on the calculated price of the index.
Let’s take a closer look at Apple and see how its massive size influences a sub-index within the S&P 500. Standard and Poor’s subdivides the capitalization-weighted S&P 500 index into 10 major industry groups. Information Technology is one of the 10 industry groups and its biggest component is Apple – the world’s largest company as measured by market capitalization. MarketWatch pointed out that between the all-time stock market high on October 9, 2007 and August 20, 2012, the Information Technology sub-index of the S&P 500 was up an impressive 16.6 percent. However, if you remove Apple from the equation, the index would be down 4.1 percent. That’s a huge change just due to one stock.
Yes, it is important to monitor the broad stock market indexes to gauge the overall health of the stock market. However, it’s also necessary to look under the hood and understand what’s driving the performance. Sometimes the headline performance numbers are misleadingly driven by a relatively small number of stocks that, by quirk of a high stock price or large market cap, have an outsize influence – good or bad – on the headline number.
The rest of the report can be found here.
Please be sure to visit the Parks Wealth Management website at www.parkswm.com.
James T. Parks, CFP®, AEP, AIF
President and Wealth Advisor