June 21, 2018
Since my oldest son is preparing for the ACT this summer, this week’s To Inform portion of Wealthnotes is a test question:
Based on popular market indexes, which of the following statements is CORRECT?
- U.S. stock performance is flat this year
- U.S. stock performance is up double digits this year
- U.S. stock performance is negative this year
- All of the above
Answer: All of the above.
- Year to Date (YTD) through June 20, the Dow Jones Industrial Average (DJIA), a popular index of 30 stocks, is essentially flat (up less than 1%) for the year. The DJIA is unique because the calculation of the index value is based on the stock prices of the individual companies and NOT the size of the companies. This means that even though a hypothetical aerospace manufacturing firm may be worth about $200 billion, and a hypothetical computer software firm is worth about $800 billion, the aerospace manufacturing firm’s share price of $300 means it has about 3 times the impact on changes in the value of the index than the software firm with a $100 share price. Companies that have the largest weights in the index belong to the industrial, health insurance and financial sectors. This week, the DJIA has been in the news because a major industrial company that was a Dow component since 1907 was “booted” out of the index. Since the industrial company in question had a share price that barely qualified as a “teenager,” the company’s impact on the value of the DJIA was negligible
- YTD through June 20, the NASDAQ Composite index is up over 13%. The NASDAQ Composite is an index that tracks stocks listed on the NASDAQ stock market and is dominated by big technology companies. According to data from NASDAQ, even though the NASDAQ Composite includes over 2500 different stocks, 5 big household name technology stocks make up over 30% of the value of the index. Since these big technology stocks have performed well this year, they have driven the value of the NASDAQ index.
- YTD through June 20, the performance of the Russell 1000 Value Index is negative. The Russell 1000 Value index focuses on stocks with “value” characteristics especially low price to book (P/B) ratios. Like the other indexes just discussed, the top components of the Russell 1000 Value index will consist of well-known household names, however, those names come predominantly from the financial, energy, and healthcare sectors and are not dominated by technology.
- All of the above is the correct answer!
So, what do we make of the disparity in performance between the different indexes? When we look under the hood of the stock market, there is a huge difference in the performance of “growth” and “value” stocks. The difference is best explained when we look at sectors – technology stocks have been dominant so far in 2018 while other sectors such as financials, utilities, communications, and industrials have flat to negative returns. Looking forward, this difference in performance has our attention. To quote Wayne Gretzky, we “want to skate where the puck is going to be” and value stocks, especially those that pay nice dividends, are looking attractive.