Why Stock Indexes Tell Different Performance Stories
U.S. stocks have been on a roller coaster.
Driven by inflation and recession fears for much of the year, investors became a little more sanguine recently, helping the market to pare its losses. The S&P 500 was down almost 14% year to date as of Friday, improving from the 22.5% loss it had at its worst point.
At least that’s the snapshot of the market investors get by looking at the SPDR S&P 500 ETF Trust (SPY), the largest exchange-traded fund tracking U.S. stocks. But that’s not exactly representative of the return achieved by the average stock in the market.
For that, one can look at something like the Invesco S&P 500 Equal Weight ETF (RSP) or the Invesco Russell 1000 Equal Weight ETF (EQAL), which are each down 10.2% on a year-to-date basis.
Megacaps Lag
The divergence can be traced to the makeup of the ETFs. The S&P 500 Index underlying SPY is market-cap-weighted, meaning larger companies get a larger weighting in the fund. In an environment where large megacap tech stocks have underperformed, that’s been a drag on the S&P 500.
Five of the S&P 500’s largest holdings—Apple Computer Inc., Microsoft Corp., Amazon.com Inc., Alphabet Inc. and Meta Platforms Inc.—together make up nearly 21% of SPY. A reversal in the once- high-flying tech trade has taken a toll on some of these stocks.
With the exception of Apple, which is down 8%, each of those stocks retreated at least 16% since the start of the year.
It’s no wonder then that SPY, with almost a fifth of its portfolio in these heavyweights, has lagged.
Apple = Diamondback Energy
While SPY has been burdened by oversized positions in megacaps and technology (the sector makes up 28% of the fund), RSP and EQAL have been relatively insulated thanks to their much smaller exposure to those stocks.
As their names suggest, the two ETFs equal-weight their holdings, giving the same importance to a stock like Alphabet, with a $1.5 trillion market cap, to a stock like Diamondback Energy, with a $22 billion market cap.
RSP’s holdings include all the stocks in the large cap S&P 500, while EQAL takes its stocks from the Russell 1000, a broader index that includes midcaps.
As one can imagine, giving the same weighting to soaring energy stocks as beaten-down tech stocks would be a net positive at a time like this. RSP and EQAL hold about 16% and 14%, respectively, of their portfolios in technology, a significant weighting, but well below the S&P 500’s tech exposure.
Missing Blue Chips
As the returns for SPY, RSP and EQAL suggest, not all stock market indices are created equal. The Dow Jones Industrial Average, the famous U.S. stock market gauge with a 126-year history, is another case in point. The SPDR Dow Jones Industrial Average (DIA), an ETF that tracks the 30-stock index, is down by 9.6% year to date.
Considered an exclusive index, the Dow has historically held stocks of the titans of American industry, the bluest of the blue chips.
But due to the quirky nature of the index, whereby the Dow weights its holdings based on share price, it has been unable to include key tech stocks like Amazon or Alphabet, because their high stock prices would lead them to completely dominate the index. That’s something that’s unintentionally helped the index’s returns this year.
Instead, the Dow holds enormous positions in stocks like UnitedHealth Group (11%), Goldman Sachs Group Inc. (7%), McDonald's Corp. (5%) and the Boeing Company (3%).
Though it excludes Amazon and Alphabet, the Dow does hold positions in a few megacap tech stocks like Microsoft (6%) and Apple (3%).
Incidentally, both Amazon and Alphabet recently did 20-for-1 stock splits, which increased their shares outstanding by a factor of 20, and reduced their share prices to one-twentieth of what they were before.
For the most part, the splits are merely cosmetic; they don’t affect the companies’ fundamentals. But in the case of the Dow, which happens to be price-weighted, the stocks are suddenly at the level at which they could join the Dow without tilting the index too much toward one or two stocks.
If Alphabet and Amazon do join the Dow in the future, as many expect, the index will become much more vulnerable to price swings in tech names.
The Tech-Heavy Nasdaq
The last of the big three indexes, along with the S&P and Dow, is the Nasdaq.
The Nasdaq Composite is a quirky index, and perhaps even more arbitrary than the Dow. It’s a market-cap-weighted index, but one that only selects its holdings from those stocks listed on the Nasdaq exchange. If a stock is listed on the rival New York Stock Exchange, you won’t find it in the index.
The Nasdaq is well-known for being a tech-heavy index since so many stocks have their primary listings on that exchange. That includes the big five—Apple, Microsoft, Amazon, Alphabet and Meta—which together make up 39% of the Nasdaq Composite, fueling the index to losses of 21% so far this year.
The Fidelity NASDAQ Composite Index Tracking Stock (ONEQ), which tracks the index, holds a whopping 42% of its portfolio in the tech sector (Amazon, Alphabet and Meta aren’t classified as technology stocks in this instance).
With more concentrated exposure to the megacaps and tech than even SPY, it’s not surprising to see the Nasdaq and ONEQ performing so poorly this year.
Different Snapshots
A disappointing 13% decline for the S&P 500, a smaller 9.6% drop for the Dow and a brutal 21% loss for the Nasdaq—the snapshot of U.S. stock market returns has varied significantly this year.
Which represents the “true” market? Well, there’s no right answer. If you want a representation of the majority of investors’ experience, then the S&P 500, which has $5 trillion tracking it, is probably the best gauge. If you want to see what the average stock is doing, then the 10.2% loss for EQAL might be more telling.
The Dow and Nasdaq probably aren’t the best indices to track, given how arbitrary they are, but for historic reasons, you’ll still often hear them quoted in the media, so it’s worth knowing why they’re doing what they’re doing.
One final point—just because certain indices are outperforming this year doesn’t mean they will outperform going forward. As always, past performance is no guarantee of future results.
Follow Sumit Roy on Twitter @sumitroy2
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