The S&P 500 and How It Works
How the S&P 500 Tells You About America's Health
The S&P 500 is a stock market index that tracks the stocks of 500 large-cap U.S. companies. It represents the stock market's performance by reporting the risks and returns of the biggest companies. Investors use it as the benchmark of the overall market, to which all other investments are compared.
Over the last 10 years, it has returned 11.09% per year. As of Jan. 14, 2020, it had a YTD return of 26.65%. S&P stands for Standard and Poor, the names of the two founding financial companies.
How It Works
The S&P 500 tracks the market capitalization of the companies in its index. Market cap is the total value of all shares of stock a company has issued. It's calculated by multiplying the number of shares issued by the stock price. A company that has a market cap of $100 billion receives 10 times the representation as a company whose market cap is $10 billion. The total market cap of the S&P 500 is $23.5 trillion. It captures 80% of the market cap of the stock market.
The index is weighted by a float-adjusted market cap. It only measures the shares available to the public. It does not count those held by control groups, other companies, or government agencies.
A committee selects each of the index's 500 corporations based on their liquidity, size, and industry. It rebalances the index quarterly, in March, June, September, and December. To qualify for the index, a company must be in the United States and have a market cap of at least $6.1 billion. At least 50% of the corporation's stock must be available to the public. Its stock price must be at least $1 per share. It must file a 10-K annual report. At least 50% of its fixed assets and revenues must be in the United States. Finally, it must have at least four consecutive quarters of positive earnings.
As of Jan. 14, 2020, the 10 largest companies, with a weighted market cap, in the S&P 500 were Apple; Microsoft; Amazon; Facebook; Berkshire Hathaway B; JP Morgan Chase; Alphabet Inc. A; Alphabet Inc. C; Johnson & Johnson; and Visa.
The makeup of the S&P 500 industries reflects that of the economy. According to the S&P Dow Jones Indices, as of Jan. 14, 2020, the S&P 500 sector breakdown was:
- Information Technology: 23.2%
- Health Care: 14.2%
- Financials: 13%
- Communication Services: 10.4%
- Consumer Discretionary: 9.8%
- Industrials: 9.1%
- Consumer Staples: 7.2%
- Energy: 4.3%
- Utilities: 3.3%
- Real Estate: 2.9%
- Materials: 2.7%
How the S&P 500 Is Different from Other Stock Market Indices
The S&P 500 has more large-cap stocks than the Dow Jones Industrial Average. The Dow tracks the share price of 30 companies that best represent their industries. Its market capitalization accounts for almost one-quarter of the U.S. stock market. The Dow is the most quoted market indicator in the world.
The S&P 500 has fewer technology-related stocks than the NASDAQ; as of June 28, 2019, 55% of NASDAQ allocations are in technology compared to 22% for the S&P 500. The NASDAQ also includes the stocks of companies that are privately-owned.
Despite these differences, all these stock indices tend to move together. If you focus on one, you will understand how well the stock market is doing. In other words, you don't have to follow all three.
|January 3, 1950||16.66||Record closing low. 1st close.|
|June 4, 1968||100.38||1st time above 100|
|October 19, 1987||224.84||Black Monday largest % loss (20.5%)|
|March 24, 1995||500.97||1st close above 500|
|February 2, 1998||1,001.27||1st close above 1,000|
|October 9, 2007||1,565.15||Highest close before financial crisis|
|October 13, 2008||1,003.35||Largest % gain of 11.6%.|
|March 28, 2013||1,569.19||New record high|
|August 26, 2014||2,000.02||1st close above 2,000|
|September 21,2018||2,929.67||Record closing high|
|October 3, 2018||2,937.06||Highest intra-day|
(Source: Yahoo Finance S&P 500 Historical Data.)
History and Ownership
The S&P 500 was officially introduced on March 4, 1957, by Standard & Poor. McGraw-Hill acquired it in 1966. The S&P Dow Jones Indices owns it now. That is a joint venture between McGraw Hill Financial, CME Group, and News Corp, the owner of Dow Jones. The S&P Dow Jones Indices publishes over 1 million indices.
How to Use the S&P 500 to Make Money
Although you can't invest in the S&P, you can mimic its performance with an S&P Index fund. You could also buy shares of stocks that are in the S&P 500. Be sure to weight them in your portfolio according to the market cap, as the S&P does.
You should use the S&P 500 as a leading economic indicator of how well the U.S. economy is doing. If investors are confident in the economy, they will buy stocks. Some experts believe the stock market can predict what the savviest investors think the economy will do in about six months.
Besides following the S&P 500, you should also follow the bond market. When stock prices go up, bond prices go down. There are many different types of bonds. They include Treasury bonds, corporate bonds, and municipal bonds. Bonds provide some of the liquidity that keeps the U.S. economy lubricated. Their most important effect is on mortgage interest rates. To help you follow the bond market, Standard & Poor's also rates bonds.
Since the S&P 500 only measures U.S. stocks, you should also monitor foreign markets. That includes emerging markets like China and India. It's also good to keep 10% of your investments in commodities, like gold. They tend to hold value longer when stock prices drop.
The Bottom Line
As a stock market index, the S&P 500 is regarded as its best health gauge. It tracks 500 publicly traded, large-cap U.S. companies. These businesses must be listed on the New York Stock Exchange, NASDAQ, BATS, or the Investors Exchange.
The mix of industries comprising the S&P 500 list often reflects the economic makeup of the United States. According to the 2017 index, information technology was the lead sector driving the American economy.
Although the Dow is the most popularly known index, investors usually look to the S&P 500 when assessing how the overall market is doing. As such, this index is considered a leading U.S. economic indicator.
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