What Is ‘The Stock Market?’
A bit of history to help you decide
When I was a kid on Wall Street (1980s), we all knew what “The Dow” was. The Dow Jones Industrial Average (DJIA) was a set of the 30 most prominent public companies in America. Collectively, they were intended to represent the U.S. economy. They were household names in their industries, and the Dow was considered THE “Blue Chip” index.
Ask someone over age 50 how they keep track of how the stock market is doing, and they will likely mention the Dow. Sure, they know the S&P 500 Index as well. However, the Dow dates all the way back to 1896. The S&P 500 did not come into existence for another 61 years. And as late as the early part of this century, the S&P 500 was still fairly new to the average investor. To be clear, the S&P has been the favored index of professional investors to benchmark their behavior for a few decades now. But like other things in life and the markets, the lines tend to blur when we talk about these two indexes that track the largest companies traded on U.S. stock exchanges.
Along comes the Nasdaq
The rise of prominence of the Nasdaq Index in the late 1990s (though it started in 1971) threw a wrench into this battle over “what is the market.” You see, back in the 90s, investors went from concentrating on “industrial” companies to companies that were more a part of their daily lives. Specifically, technology stocks and some retail business captured the imagination of a new generation of investors.
The Nasdaq brought…dare I say…sex appeal to investing. It did so in a way that did not exist previously. The advent of financial television and then the internet starting in the mid-1990s lit a fire under investors. Furthermore, those now-iconic tech businesses helped spur economic growth that had not been seen since the industrial revolution.
401k plans increasingly replaced pensions as the main savings vehicle. All of this helped solidify the stock market as a place where people felt comfortable investing a big chunk of their retirement savings. This has continued until today, albeit with a pair of “hate” periods mixed in with the “love” when the Dot-Com Bubble burst in 2000, and again when the Financial Crisis hit in 2007.
The market today
Why I am reviewing all this history? Because it relates directly to the danger signs regarding the current investment climate. That, in turn, focuses us back on where a very large portion of investment capital is today: invested in S&P 500 Index funds.
This is the root of so much “FOMO” (fear of missing out) on market gains that I fear will ultimately unravel many retirement dreams. It is why the S&P 500, which virtually ignores most of its 500 members because the weighting system is so skewed, has sucked in so many unsuspecting investors.
Dot-Com bubble revisited?
For about the past year, it seems that every day I find something else that reminds me of the Dot-Com era, or some statistic that has not occurred since that time. I don’t think that is a coincidence: the speculation over IPOs, the urgent calls for the Fed to lower interest rates while the economy is still hanging in, and many, many eerie similarities.
However, in one important area, the current climate is very different from that 1999-2000 time period. Specifically, tech stocks are not dominating the market (though they continue to dominate the headlines). The tech stock weighting of both indexes is about 21%. Back in 1999, it was nearly double that for the S&P 500, due to surging prices of a narrow group of tech stocks.
This time around, the tech stock dominance of that prior era is not being repeated. Perhaps that is some glimmer of hope for uber-bullish investors.
The chart below shows you how that domination 20 years ago created a Nasdaq frenzy, which also lifted the S&P 500. The “lowly” Dow, with its lower tech weighting, barely advanced. This is less likely to happen today because the Dow did not have too many tech names back then, and they were not the new favorites like Microsoft, Apple and Intel.
Currently, those types of companies are now part of the Dow, and so it looks more like the S&P than it did 20 years ago. That is one factor that has caused the same trio of indexes to behave very differently during the past 9 months (chart below) than they did in the last 9 months of the Dot-Com bubble (chart above).
So, what is “The Market?”
Frankly, the best answer to that question is whatever investment universe you consider the most fitting for the investment goals you personally are trying to reach. If you are young and aggressive, why look at the S&P 500 or the Dow alone when there is a whole wide world out there to consider? And even if you are the type of investor who feels a sense of relative security from knowing you are investing in Blue Chip companies, why settle for the mix of weightings to those companies that the market has set?
This is where investors get messed up. They assume the indexes are a fit for them. Perhaps the types of companies in those indexes are a good universe for you to consider. But, why settle for mimicking the index weights of the companies? And spare me the “but it has done so well that way” argument! 10 years ago, amid a decade of zero return in both indexes, that was a different discussion.
What you can do now
The best thing to do now is to understand these differences and apply them to your own life situation as an investor. It is part of knowing what you own and why you own it. The closer you are to retirement, the more critical this is.
In conclusion, understanding how the market functions today versus 5, 10 or 20 years ago is essential. Otherwise, you risk being the proverbial deer in the headlights. Because there will be another bear market, and that will be too late to figure out what’s going on. After all, “The Market,” like investing itself, is what you make of it.
Comments provided are informational only, not individual investment advice or recommendations. Sungarden provides Advisory Services through Dynamic Wealth Advisors
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