Investors, politicians, and TV talking heads all talk about “the market,” but what does that phrase really mean?
To start, there are different markets for investments—a stock market, a bond market, and a currency market, to name a few. But even when you narrow in on the stock market, for example, what do we really mean when we say, “The stock market fell x% today?”
In reality, the generic term often refers to investment exchanges, benchmark indices, sectors of the economy, and more.
Indices versus exchanges
When people mention “the stock market” going up or down, they aren’t referring to an actual marketplace. That type of market is actually termed a stock exchange. The New York Stock Exchange (NYSE) on Wall Street may be the most famous stock exchange, but there are others.
There are also investment exchanges for assets other than stocks: Commodities are traded on the New York Mercantile Exchange (NYMEX), the Chicago Mercantile Exchange (CME) hosts futures, options are traded on the Chicago Board Options Exchange (CBOE), and so on.
It’s also important to note that many investments trade on multiple exchanges. You can buy shares of Apple via the NYSE or the Nasdaq, similar to the way you can buy an iPhone at a T-Mobile or a Target.
While stock exchanges are the true marketplace for stocks, they aren’t “the stock market” that people refer to. People talking about the stock market are usually referencing one of the major indices (or indexes) that track performance.
The most prominent in the U.S. include:
- Dow Jones Industrial Average
- S&P 500
- Nasdaq Composite Index
Each has its own trademark characteristics, which we’ll get into more detail about below.
Dow Jones Industrial Average
The Dow Jones Industrial Average—sometimes referred to by its ticker, DJIA, or more commonly, the Dow—is one of the oldest indices. As such, it’s often used as a benchmark by the mainstream media. When you read a headline about markets surging or plunging on any given day, it’s likely they’re referencing the Dow.
The Dow includes 30 stocks, giving it a narrow scope. Those 30 stocks are large, well-known companies from different sectors of the economy, including retail, finance, pharmaceuticals, media, and transportation. Apple, Disney, Walmart, American Express, Caterpillar, and Johnson & Johnson are just a few of the names you might recognize from the Dow.
The Dow is a price-weighted index, meaning companies with higher share prices influence the overall index more than companies with lower share prices.
While these 30 stocks create a nice snapshot of how the economy is doing overall, if you are invested beyond these 30 companies, it may not be the most representative measure of stock market performance.
S&P 500
The S&P 500 takes a wider look at stocks, since it tracks 500 large, publicly traded companies. More news outlets are using the S&P 500 as a benchmark instead of the Dow thanks to its wider scope.
(It’s worth noting that both the S&P 500 and the Dow are owned by parent company S&P Global. While many people refer to the S&P 500 as simply the S&P, it isn’t the most accurate phrasing.)
The S&P 500 is weighted by market capitalization (cap), instead of price. (Market cap reflects the overall value of the company—its share price multiplied by number of available shares.) As of April 2023, Microsoft and Apple combined had a market cap of $4.74 trillion, or the 14% of the index.
If something happens in tech, and the share price at both Apple and Microsoft increases, it has the potential to lift the value of the index overall. In other words, it can boost the entire stock market, as measured by the S&P 500.
At the same time, if share prices tumble at either Apple or Microsoft, it has the potential to drag the S&P 500 down.
Nasdaq
Nasdaq operates several stock exchanges (as noted earlier) and indices to track them. Because the Nasdaq stock exchange historically focused on technology stocks, the indices that track it have a reputation for being tech focused as well.
However, now that technology is a major driver at many companies regardless of sector, the better distinction for the Nasdaq Composite Index may be that it does not track financial stocks. If there’s a major move in bank stocks, for example, the Nasdaq is insulated from those movements.
The Nasdaq Composite Index tracks roughly 2,500 companies and tends to include more growth stocks. For instance, technology companies often go public (an initial public offering, or IPO) on the Nasdaq Exchange and end up included in the Nasdaq Composite Index.
Because of this, the Nasdaq can sometimes be more volatile than other indices.
The global stock market
These days the stock market is global. Many U.S.-based companies are traded on international stock exchanges, just as many foreign companies are listed on American exchanges. Similarly, the Dow, S&P 500, and Nasdaq reflect a global market.
That said, investors focused on foreign markets may track local indices to monitor those stocks. The main index for tracking stocks in the UK, for instance, is the Financial Times Stock Exchange 100 Index (FTSE). In Germany, it’s the DAX 40, and France has the CAC 40.
Often, analysts who discuss European markets are referencing the FTSE, DAX and CAC in aggregate. The same goes for Asia, where the three major benchmarks tend to be the Shanghai Composite Index (tracking mainland Chinese markets), the Hang Seng (based in Hong Kong), and the Nikkei in Japan.
Lastly, investors may look at the MSCI Emerging Markets Index, which tracks large- and mid-cap companies across up-and-coming economies throughout India, Brazil, South Korea, and more.
The importance of benchmarks
Indices can be built to track sections of a market, rather than the market overall. Often, these indices can be used as benchmarks to help analyze investment performance.
For instance, a number of indices track growth stocks or value stocks. There are also indices focused on specific sectors of the economy: financials, transportation, retail, biotechnology, and the list goes on.
Different investment funds, whether it’s an exchange-traded fund (ETF) or mutual fund, tend to measure their performance against these benchmarks. Some funds are designed to simply track these indices overall, while others might try to outperform them.
It’s important to note that benchmarks aren’t specific to stocks. For instance, the Bloomberg U.S. Aggregate Bond Index is the major benchmark for tracking bond performance overall. It looks at total return (both the price and anticipated yield) of a portfolio of bonds, including U.S. Treasuries, government, and corporate debt. Because it looks at a large array of bonds, the Bloomberg U.S. Aggregate Bond Index is like the S&P 500 of tracking indices for bonds. Narrower indices exist to help benchmark more specific investments, including the Bloomberg’s U.S. Government index or its U.S. Corporate index.
We use benchmarks as a point of reference to help investors understand their own portfolio’s performance. It can be more confusing than helpful to compare a diversified portfolio, designed to reflect your personal goals, to a vague concept of “the market.” Benchmarks help create an apples-to-apples comparison.
For example, if 20% of your portfolio is invested in growth stocks, it may make more sense to use the Russell 1000 Growth index as a benchmark, rather than the S&P 500. For value stocks, it might be the Russell 1000 Value index.
The idea of the “market” can be both broad and complex, which is why we tend to focus on individual goals when discussing investments, versus market performance overall. If you have questions about the benchmarks we discuss, or headlines about the market overall, reach out.
