Skip to main content

Sound Advice: January 17, 2024

The Market Indexes are Dominated by a Few Stocks

Yes, it's true that in many stock markets, a small number of stocks can have a significant impact on the overall market averages. This phenomenon is often referred to as market concentration. Here are a number of factors to keep in mind when considering this aberration.

1.     Market Capitalization Weighting: Many stock market indices, like the S&P 500, are weighted by market capitalization. This means that companies with larger market capitalizations (total market value of outstanding shares) have a more substantial impact on the index's value. If a few large companies experience significant price movements, they can sway the entire index.

2.  Equal Weighting: When all the stocks are given equal weights, the results of the overall market index are quite different.  Over the latest five years, ending last November 1st, the cap-weighted S&P 500 Index rose 54.4%.  When results are viewed on an equal-weighted basis, they fell far short: 35.3%. 

             (The green line is cap-weighted; the blue line is equal-weighted.)



3.     Industry Dominance: Certain industries or sectors might be represented by just a handful of major companies. For example, in the technology sector, companies such as Apple, Microsoft, Amazon, and Google parent company Alphabet, often referred to as FAANG stocks, have a significant influence on market indices due to their size and market capitalization.

4.     Investor Sentiment: Popular or trendy stocks that capture the attention of investors can experience rapid price movements. If these stocks are included in major indices, they can lead to significant fluctuations in the averages.

5.     Economic Impact: Large multinational corporations that operate globally can be affected by economic events in multiple countries. Economic changes in these regions can impact the stock prices of these companies, influencing the overall market averages.

6.     Index Funds and ETFs: Many investors opt for index funds and exchange-traded funds (ETFs) that track major indices. These funds invest in the same stocks that are part of the index, magnifying the impact of these stocks on the market averages.


     Although the dominance of a few stocks can lead to short-term volatility in market averages, it's important for investors to diversify their portfolios to spread the risk. Diversification involves investing in a broad range of assets, including different sectors, industries, and geographic regions. By diversifying, investors can reduce the impact of individual stock movements on their overall investment portfolio, potentially mitigating risks associated with market concentration.

N. Russell Wayne, CFP

Any questions?  Please contact me at nrwayne@soundasset.com

Comments

Post a Comment

Popular posts from this blog

Sound Advice: February 21, 2024

800-000-0000 That’s 800-000-0000 Again, 800-000-0000 That’s the typical closing for the hard sell commercials that are increasingly polluting media airwaves.   These are the commercials for products or services you rarely need or most definitely should avoid. A substantial number are on behalf of groups of attorneys who would have you believe that you and many others may be entitled to cash compensation for having used or being exposed to some evil item or substance some time in the last few decades.   The pitch always includes a comment that there’s no cost to you unless there is a settlement in your favor. Much of this is rubbish, but when the appeal suggests that there’s nothing to lose, why not take a shot.   And, as you would expect, “advisors” are standing by 24/7 to take your call and help get the process in motion.   What kind of advisor would be available at 3 a.m.? One version of this approach pops up every year between October 15 th and Decemb...
Post a Comment
Read more

Sound Advice: September 21, 2022

The Professional Approach To Stock Selection There are various approaches to stock selection, but the two that predominate are fundamental analysis and technical analysis.  Fundamental analysis is a numbers-based method that evaluates key factors such as income and financial health, including the past, present, and future.  Technical analysis emphasizes movements and formations of stock prices. Fundamental analysis is based on factors that over time have proved to have a meaningful impact on stock price movements.  The optimal picture of corporate profitability is steady growth, both in the past and, prospectively, in the coming years.  Steady growth is rewarded by higher valuations of underlying earning power than those accorded companies with erratic progress. When professionals screen (filter) the data of the broad universe of stocks, they look for companies that move ahead every year, regardless of the prevailing economic conditions.  Although high pas...
Post a Comment
Read more

Sound Advice: July 26, 2023

Is Day Trading a Good Idea? Day trading can be both exciting and potentially profitable, but it also comes with significant risks and challenges. Whether it's a good idea depends on several factors, including your financial situation, risk tolerance, time commitment, and knowledge of the markets. Here are some considerations to keep in mind: Risk and volatility: Day trading involves buying and selling securities within a short time frame, often within the same day. This exposes you to the inherent volatility and risks of the market. Prices can fluctuate rapidly, and unexpected events can have a significant impact on stock prices, making it challenging to consistently make profits. Time commitment: Day trading requires a substantial time commitment. It involves closely monitoring market movements, conducting research, and executing trades. It can be stressful and demanding, as you need to be actively engaged in the market during t...
Post a Comment
Read more