Kevin Greenard: Obtaining clarity on market indices and benchmarks

Kevin Greenard

Anyone following the business news or reading financial literature is aware of market indices.

An index is a select number of stocks listed on an exchange. These selected stocks are typically designed to provide an approximation of the performance of the broad index. This means that each index is typically within one country or one geographic area, and some countries have numerous indices. It is important to note that not all indices are valued the same way.

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The key for most investors is to determine which index is the closest benchmark to gauge their overall stock market performance. Indices provide us a system of measuring change that can be documented and reported in the newspaper, radio, internet and television. Investors should use caution when looking at this information to make investment decisions and to monitor their own portfolio. Let’s start by first obtaining an understanding of the major indices used around the world.

To assist you in obtaining a better understanding of the various “equity” benchmarks, we have included a few points below, sorted geographically.

United States and Canada

If you have equities within your portfolio, then chances are one, or more, of the four indices below could be a benchmark you could look at periodically.

• Dow Jones Industrial Average (US): Consists of the 30 largest and most widely held public companies in the United States.

• S&P 500 Index (US): S&P stands for Standard & Poor’s, and this Index consists of just over 500 large companies, most of which are American.

• NASDAQ Composite Index (US): NASDAQ stands for National Association of Securities Dealers Automated Quotation System, and this Index is made up of over 3,300 companies.

• S&P/TSX Composite Index (Canada): TSX (formerly TSE), stands for Toronto Stock Exchange, and this Index consists of approximately 231 large companies as measured by market capitalization, all of which are Canadian.

If you have expanded your portfolio beyond Canada and the United States then we have summarized a few points of other major indices around the world below.

Americas

• IPC Index (Mexico) is a market capitalization weighted index containing 35 companies.

• Bovespa Index (Brazil) isbest known as Ibovesa and is comprised of the most liquid stocks traded on the Sao Paulo Stock Exchange. This Index has a broad range of companies.

Europe

• Euro Stoxx 50 (Eurozone) is a European Index for the Eurozone, holding 50 of the largest and most liquid stocks from 9 countries within the Eurozone.

• FTSE 100 Index (United Kingdom) is a market capitalization weighted index representing the performance of the 100 largest UK-domiciled companies. FTSE stands for Financial Times and the London Stock Exchange.

• CAC 40 Index (France) consists of 40 large French companies as listed on Euronext Paris.

• DAX Index (Germany) consists of the 30 large German companies trading on the Frankfurt Stock Exchange.

• IBEX 35 Index (Spain)iscomprised of 35 large Spanish companies traded on the Bolsa de Madrid which is Spain’s primary stock exchange.

• FTSE MIB Index (Italy)consists of 40 large Italian companies traded on Borsa Italiana’s (BIt) MTA market.

• AEX Index (Netherlands)iscomposed of Dutch companies that trade on Euronext Amsterdam and is comprised of a maximum of 25 of the most actively traded securities on the exchange.

• OMX Stockholm 30 Index (Sweden) is a market value weighted index that consists of the 30 most-traded stock classes.

• SWISS Market Index (Switzerland) is made up of 20 of the largest and most liquid stocks. The index is capped so that no one constituent exceeds a weight of 18 per cent of the overall index.

Asia and Pacific

• Nikkei 225 (Japan) is a stock market index for the Tokyo Stock Exchange (TSE). The Nikkei 225 is the most watched index of Asian stocks.

• Hang Seng Index (Hong Kong) is a free float-adjusted market capitalization weighted stock market index in Hong Kong consisting of 50 companies broken down by four main sectors.

• S&P/ASX 200 Index (Australia) is a market capitalization weighted and float-adjusted stock market index of 200 stocks listed on the Australian Securities Exchange.

Largest Company in Canada

Over the years, we have seen several companies become Canada’s largest company by market capitalization. Few investors can forget the rise of Nortel Networks. It had become so large in August 2000 that it was more than ten times the size of the second largest company in Canada.

Research in Motion became the most valuable company in Canada in October 2007. Remember when natural gas prices spiked and Encana became the largest company in September of 2005? How about Valeant Pharmaceuticals? This stock became the largest company in Canada by market capitalization in July 2015.

On May 6, 2020, Shopify overtook Royal Bank of Canada to become Canada’s most valuable company. It remains to be seen if Shopify will continue its dominance or if it will suffer a similar fate to its predecessors.

What is a Market Weight Index?

There are a couple of different terms used such as “market value-weighted index” and “capitalization-weighted index” that mean the same thing as a market weighted index. Essentially, with a market weighted index, a security’s weighting is based according to the total market capitalization of the security. This means that larger capitalization securities will have a higher weighting percentage in the index and have a greater influence on the index as the price of the security rises or falls.

Let’s take a look at the TSX Composite Index which is a market weighted index. On January 1, 2020, the TSX started the year at 17,063.43 and was at 16,169.21 as of July 31, 2020 – a decline of 5.24 per cent.

In that same time period the top point contributor to the index was Shopify which contributed 637.75 points. Barrick Gold was the second top point contributor adding 187.88 points to the index.

As noted above, Shopify has become the biggest stock in Canada. If you were to take Shopify out of the index then the index would be down 10.56 per cent. This shows how much one security can influence an index in a market-weighted index.

What is a “Capped” Index?

If you are following an index that has the word “Capped” in it, then they will put an upper limit on the weight of any single security. For example, you can monitor the S&P/TSX Capped Composite Index which restricts the weighting of any security to a maximum of 10 per cent. Another example of a capped index is the SWISS Market Index which capped its weighting at 18 per cent in 2017 to address some of the larger capitalized stocks such as Nestle and Novartis.

What is an Equal Weight Index?

An equal-weighted index is comprised of a group of companies. The index holds an equal dollar amount in each stock. Each company’s stock carries equal importance in determining the performance and total value of the index. Many market-weighted indices will have an equal weight index equivalent. For example, the S&P 500 Index has an equal weighted version where it takes all the constituents of the S&P 500 Index and assigns an equal weight to each.

Let’s look at how the S&P 500 Index and its equal weighted counterpart compare.

Similar to the market-weighted S&P/TSX Composite Index, a few large companies can have a huge influence on the performance of the index.

On January 1, 2020, the S&P 500 Index started the year at 3,230.78 and was at 3,271.12 as of July 31, 2020, an increase of 1.25 per cent. Three of the largest capitalized companies on the index contributed 176.84 points to the index (Amazon +66.33 points, Apple +66.10 points, and Microsoft +44.41 points). If you look at the equal weighted version of the S&P 500 then you have a much different story. Using the same time period of January 1, 2020 to July 31, 2020 the equal weighted S&P 500 Index posted a decline of 7.60 per cent.

In our next article, we will discuss how some investors use these indices as part of their investment strategy.

Kevin Greenard CPA CA FMA CFP CIM is a portfolio manager and director of wealth management with The Greenard Group at Scotia Wealth Management in Victoria. His column appears every week at timecolonist.com. Call 250-389-2138. greenardgroup.com

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