The two most common indexes watched and the two most common exchange traded funds (ETFs) traded are the ones that track the Dow Jones Industrial Average and the S&P 500. What do you really know about them, though?
Both indexes generally move in tandem, with both either showing gains or losses. However, the magnitude of these moves can differ substantially because of the composition and holdings of the indexes.
The Dow is price-weighted and only holds the top 30 U.S. companies, whereas the S&P 500 is market-cap weighted and holds 500 U.S. companies. As a result of this underlying characteristic, one of the two benchmarks will outperform the other depending on the time period, states Prestbo of MarketWatch.
History further supports this. Over the last decade, the Dow has beaten the S&P 500 in seven times by an average of 4.5%. If one picked a different 10-year span, the results could differ significantly. When considering the most recent market collapse, the Dow fell from its peak a lot quicker than the S&P 500 did, the Dow lost 4.7% in the fourth quarter and the S&P 500 dropped 3.8%.
The reason for this aforementioned inequality is that the S&P 500 holds smaller than mega-cap stocks, unlike the Dow. What’s alarming is that the bottom layer of market capitalization, which is about 20% of the S&P 500, accounted for 35% of the S&P 500’s loss.
Another reason could be the weighting of certain sectors. For example, the decisive group in last years market collapse was Oil & Gas, which caused 4.6% of the S&P 500’s decline as compared to 1.4% for the Dow. Why such a huge discrepancy one may ask? The answer is fairly simple. The Dow index holds only two Oil & Gas stocks, Chevron (CVX) and Exxon Mobil (XOM), whereas the S&P 500 hold these and an additional 33 energy stocks, all of which were affected by the drop in crude oil.
Another sector that was made its mark was technology, which chipped away 4% from the Dow as compared to 6.8% from the S&P 500. The Dow holds four technology stocks as compared to 60 held by the S&P 500. Teh opposite is also true. When looking at industrials, the Dow holds five stocks which were all down and pushed the index down 9%. As for the S&P 500, it holds these five stocks in addition to 73 others, of which nine were either in positive territory or neutral, enabling the sector to account for 5.2% of the index’s decline.
It is safe to say that identical moves by component stocks can produce different results in the two indexes, depending on how they are weighted and measured. So which one should an investor follow? It is dependent on the investor’s personal preference. The Dow is more concentrated than the broad S&P 500, which could be either a good or bad thing. As for both indexes, they offer industry diversification and good exposure to the overall markets. When considering the S&P 500, keep in mind that its allocation to smaller stocks can overshadow the dominance of the big stocks and can act as headwinds or tailwinds to impede or enhance overall performance.
From an ETF perspective, the Diamonds Trust Series 1 (DIA), is a good inexpensive way to track the Dow. The ETF is down 10.3% year-to-date and has 30 holdings, all of which are large- and mega-cap, just like the Dow.
A cheap and efficient way to grab exposure to the S&P 500 is through the SPDR S&P 500 (SPY), which is down 7.5% year-to-date.
Remember to always have a strategy and do your homework before making your choice.
For full disclosure, some of Tom Lydon’s clients own shares of SPY.
Kevin Grewal contributed to this article.