Turn on any news channel, open the financial section of the paper or click on your favorite news website and you are bound to hear about records being broken on Wall Street. Earlier this year, headlines announced the Dow was on track to break 14,000, and then it did. Now, only a few months later, the Dow broke another record topping 15,000. Meanwhile, the S&P 500 and Nasdaq have been quietly advancing to impressive positions as well but with much less fanfare and media attention. So what do these indices and numbers really mean?
Standard & Poor's 500
Most experts consider the Standard & Poor's 500, also called the S&P 500, to be representative of the stock market as a whole. The index provides a broad snapshot of the overall U.S. equity markets with 500 stocks that account for 70 percent of U.S. equities. Selected stocks are based on market size, liquidity and sector with most stocks representing large-cap or mid-cap corporations. When news or analyst research reports say that the stock market gained or lost ground, it is based on the S&P.
Dow Jones Industrial Average
In contrast, the Dow Jones Industrial Average, commonly referred to as the Dow, represents 30 actively-traded blue chip stocks and is only a small sample of the stock market as a whole. Created in 1896, it is the most widely-used indicator of the stock market and the number that usually makes headlines. The stocks that make up the Dow are primarily industrials but it has gained in technology stocks over the years.
Nasdaq
An acronym for the National Association of Securities Dealers Automated Quotation System, Nasdaq is a computerized trading system. Unlike the American Stock Exchange (Amex) or the New York Stock Exchange (NYSE) the Nasdaq doesn't have a physical trading floor. Nasdaq quotes are a composite of approximately 5,000 stocks traded on its system.
Understand historical triggers
The Dow, S&P and Nasdaq are good indicators of the overall market but it is important to understand what affects the numbers. In 1929, speculative investing in a rising market led to panicked selling during a downturn. The Dow fell 38 points, 13.47%, on October 28 and another 30 points, 11.73%, on October 29 signaling the beginning of the Great Depression.
Yet, the numbers pale in comparison to Black Monday on October 19, 1987, when the Dow fell 108 points or 22.61%. Rather than human reaction, this was thought to be caused by program trading, computers performing rapid stock executions based on external data.
In 2008, the biggest financial crisis since the Great Depression hit the U.S. A meltdown in the financial industry led to one of the Dow's largest one-day point losses of 777 at the end of September followed by one of the largest one-day point gains of 936 only two weeks later. This was largely caused by lack of regulation over the availability of high-risk, complex financial products that attracted investors who didn't accurately understand the risk. The resulting threat of the collapse of large financial institutions sent the U.S. economy into turmoil.
Beyond broad market changes, a particular stock or sector can also have an impact on indices. The Nasdaq, which is laden with high tech stocks, shattered records in the late 90s. But as the new millennium began investors saw technology stocks fall and the once lauded Nasdaq fell 37%. Those with investments outside of tech stocks may not have experienced such a negative impact.
Know your investments, be proactive not reactive
Rather than following the hype, it is important to be an educated investor. In this day and age, it is much easier to research the stock and the company it represents and follow those headlines. But don't react too quickly. Remember the old adage to "buy low and sell high." Too often, news headlines send investors scrambling to buy a hot stock when prices are high or to dump a stock when prices are low.
Combined with your own research, it is a good idea to work with a financial advisor who can help you understand all of the factors that influence the market. Then, together, you can objectively consider the investment as part of your overall asset allocation and wealth management plan.
This article is provided by James E. Elvord, AWM, a financial advisor at RBC Wealth Management in Chicago, and was prepared by or in cooperation with RBC Wealth Management. The information included in this article is not intended to be used as the primary basis for making investment decisions nor should it be construed as a recommendation to buy or sell any specific security. RBC Wealth Management does not endorse this organization or publication. Consult your investment professional for additional information and guidance. RBC Wealth Management does not provide tax or legal advice.
RBC Wealth Management, a division of RBC Capital Markets LLC, Member NYSE/FINRA/SIPC
James E. Elvord, AWM, Financial Advisor, RBC Wealth Mgmt., 312-559-1738 or 800-683-3246, james.elvord@rbc.com .
