A stock market index is a list of representative stocks in a particular category. Likewise, a bond market index is a list of representative bonds.
Each index has a number that represents the composite value of its components. The number for the index represents a change from an original base value. The percentage of change of the number over time is more meaningful than the number itself. This percentage of change indicates how the index is performing for the market it represents. In this way, indexes show trends and changes in investing patterns and provide the means for comparisons. Many indexes are therefore used as a benchmark to gauge portfolio performance.
Robinswood Financial uses the following indexes in regular client discussions.
Dow Jones Industrial Average
Dow Jones Industrial Average (DJIA) is probably the most widely quoted and popularly used measure of stock market performance.
The Dow industrials consist of 30 large companies representing a variety of industries. This group represents about 25 percent of the market value of the New York Stock Exchange (NYSE) and less than 2 percent of New York Stock Exchange (NYSE) issues.
Since the DJIA uses a limited number of stocks, critics argue that it is not representative of the overall market.
Standard & Poor’s 500
After the Dow Jones Industrial Average, the Standard & Poor’s 500 index (S&P 500) is probably the best-known and most widely followed market indicator.
The S&P 500 is a composite of 500 companies representing nearly 80 percent of the value of common stocks on the NYSE and 30 percent of NYSE issues.
S&P 500 component stocks are chosen solely with the aim of achieving a distribution of broad industry groups that approximates the groups that make up the NYSE. Therefore, the S&P 500 is taken as a model for the composition of the total market.
NASDAQ Stock Market Composite
The NASDAQ composite index covers approximately 4,500 of the most popular over-the-counter stocks (stocks not listed on a stock exchange). This index represents many small company stocks but is heavily influenced by about 100 of the largest stocks—many of them technology stocks—listed on the NASDAQ.
By far the most comprehensive market indicator of all is the Wilshire 5000 Equity Index. As its name indicates, the Wilshire Index covers over 5,000 stocks, including all the issues on the New York (NYSE) and American Stock Exchange (AMEX), as well as the most active stocks in the over –the-counter market.
The Russell 2000 Index offers investors a barometer for the small-cap segment of the U.S. equity market. This index is completely reviewed and restructured annually to ensure larger stocks do not distort the performance and characteristics of this small-cap benchmark.
Morgan Stanley Capital International (MSCI) publishes the Europe, Australia, and Far East (EAFE) index. The EAFE index includes over 900 stocks and is the benchmark for measuring international portfolios.
As of June 2006, the MSCI EAFE Index consisted of the following 21 developed market country indices: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.
MSCI World Index
The MSCI World Index is a benchmark which measures the performance of global equity (stock) markets. The index consists of the following 23 developed market country indexes: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, United Kingdom, and the United States.
This index contains the same countries as the EAFE with the addition of the United States and Canada, which collectively make up 50 percent of the global economy.
Lehman Brothers Aggregate Bond Index
The Aggregate Bond index consolidates three component indexes: the Government/Corporate Bond Index (all investment-grade bonds), the Mortgage-Backed Securities Index (all fixed-rate, securitized mortgage pools), and the Asset-Backed Securities Index (composed of credit card, auto, and home equity loans).
There is a historical inverted relationship between the stock markets and the bond markets. When the stock markets are in a downturn, there tends to be a "flight to quality" which is seen when investors sell stocks and park assets where they sense safety. Thus when stocks go down, bonds go up.