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The S&P 500: Understanding a Market-Capitalization Weighted Index Thumbnail

The S&P 500: Understanding a Market-Capitalization Weighted Index

by Amanda Vaught, amandavaught@propel-fa.com

Watch Amanda explain this post in more detail or click here to open directly in YouTube.

The news recently reports dismal economic numbers. At the same time, they report record gains for the stock market. What is going on?

If you break the S&P 500 index down by sector, you can see numbers that make more sense given the current economic climate: Year-to Date numbers for some of the worst performing areas (shown in Figure 1) include: Department stores down -62.6%; Airlines down 55%; Travel services at -51.4%; Oil & gas equipment/services not doing well at -50.5%; Resorts and casinos with -45.4%; and Hotel REITS at -41.9%. Meanwhile, the top ten technology companies in the index have gained more than 37%.

Figure 1: The S&P 500 Index vs. Selected Sector Performance

The S&P 500 is what’s called a “market-capitalization index”.  Market capitalization reflects the size of a company.  A larger company means its returns count for more in the index.   Here, department stores fell 62.3%, but on a market-cap basis they are only 0.01% of the S&P 500. In contrast, the sectors that currently drive the positive returns in the S&P500 come from four areas –internet content, software infrastructure, consumer electronics and internet retailers. These account for more than $8 trillion in market value – that’s almost one quarter of the total value of the market.

When comparing the total returns (total returns includes the stock price and the dividends) of the standard, market-cap weighted S&P 500, the return is up 2.38% for the year.   If we compare that to the equal weight S&P 500, we can see the returns are at -6.45% for the year. See Figure 2.

Figure 2: Returns for S&P 500 Market-Cap Weighted Index vs. S&P 500 Equally Weighted Index

Many people “just buy an index” but do not fully understand what they are buying.  

This post is for informational purposes only and is not financial advice.  It is not possible to invest in an index directly. Past performance is no guarantee of future returns.