Are Stock Market Indices a Good Reflection of the Stock Market?>>

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Upon reading that Lucid Motors (NASDAQ: LCID) was going to be included in the Nasdaq 100 index, I felt a cringe that I haven’t felt since the Peloton inclusion a year prior. Lucid, the electric vehicle manufacturer that hasn’t even delivered 500 cars, is going to be included in one of America’s most prestigious indices.

Does having a recently IPO’d electric vehicle start up, included in the Nasdaq 100, accurately reflect the current climate of the stock market?

Yes, but let’s explore deeper.

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Chapter 1: Purpose

Stock market indices serve a valuable purpose for investors; they are intended to track the overall performance of the stock market.

To the average investor, the performance of a company, such as Brown-Forman Corporation (NYSE: BF.B) or Trimble Inc. (NASDAQ: TRMB) might seem trivial to their overall investing journey, but the performance of Walt Disney (NYSE: DIS), Home Depot (NYSE: HD) or Apple (NASDAQ: AAPL) might matter just a little bit more.

For this reason, most investors follow the performance of the Dow Jones, arguably the most recognizable index, to see how their portfolios are doing. The Dow Jones (a.k.a the Dow) tracks the performance of thirty large and well-known companies in the United States.

Below are the 30 companies that make up the index.

While there are some notable exemptions from the Dow, such as Starbucks (NYSE: SBUX), Amazon (NASDAQ: AMZN) or even Costco (NYSE: COST), the Dow has been followed by investors for over one-hundred years as a general indicator for the performance of the stock market, and even, the economy.

So, I guess, the question is: with thousands of companies left unaccounted for, is the Dow Jones still a reliable indicator of overall stock market performance in 2021 and beyond?

Chapter 2: Perspective

Depending on what stocks, you believe, represent the “total stock market,” you may look at one of several indexes to determine how stocks are at any given point in time.

If you are wondering about the performance of German companies, the DAX Composite, comprising of the 30 largest German companies, is the index for you. Looking at companies listed in Hong Kong? Look no further than the Hang Seng Index. Companies in the Cayman Islands? Let’s not go there…

What about in the United States? Well, we have a few choices.

The Dow Jones, as mentioned above, represents 30 select large-cap companies in the US, bar a few recognizable names.

The S&P 500, tracks (you guessed it) 500 of the largest companies in the U.S (and Ireland) and is organized into 11 industries; Basic Materials, Communication, Consumer Discretionary, Consumer Staples, Energy, Financial, Healthcare, Industrials, Technology, Real Estate, and Utilities. It is typically considered the most diversified and most representative of total stock market participation.

The S&P 500 and its industries.

Finally, we have the Nasdaq 100, known for tracking the 100 biggest companies listed on the Nasdaq Composite. This index accounts for large, growth-oriented technology companies such as Facebook (NASDAQ: FB), Google (NASDAQ: GOOG) and Tesla (NASDAQ: TSLA), mixed in with consumer staples such as Keurig Doctor Pepper (NASDAQ: KDP), Dollar Tree (NASDAQ: DLTR) and O’Reilly Automotive (NASDAQ: ORLY). By many, it is generally considered to be the “technology index” since the majority of its holdings are large software and hardware developers.

So, which of the three major indices is currently the best representation of the overall stock market? In essence, it depends on the current state of the economy.

Chapter 3: Performance

You would think that the S&P 500, the most diversified index out of the bunch, is the best indicator for the general stock market performance.

With the S&P 500, and the Dow Jones, both underperforming the Nasdaq 100 over the past 5 years, does this mean that the general stock market has performed poorly over the last five years?


Does this mean that high-growth companies such as Workday, Lululemon, and MercadoLibre have outperformed classic staples such as Disney, Home Depot, and McDonald’s?

Yes, precisely.

Thanks to the accommodative Fed that we have been blessed with, since the financial crisis of ’08, tech and high-growth companies have outperformed value and more cyclical names. Does this mean that we should forever disregard the Dow Jones? Not at all.

Dow companies are typically regarded as companies that stand the test of time. They represent an older generation of investors that have probably held Procter & Gamble (NYSEL PG) and Coca-Cola (NYSE: KO) in their portfolios since the early 70s. So, when you see the Dow Jones is up on the day, rest assure, your grandaddy’s portfolio is doing fine.

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Albeit, some Dow companies such as IBM (NYSE: IBM) and Cisco Systems (NASDAQ: CSCO) are barely even recognized by younger investors. I don’t think I ever met a single person that purchased Traveler’s Insurance (NYSE: TRV), let alone the stock. These companies are no longer the companies they used to be, and deserve to be replaced with companies that better represent the current economy (Amazon anyone?)

Maybe, this is why in 2020, the Dow Jones organizers thought it would be a good idea to push out the pharmaceutical giant Pfizer (NYSE: PFE) [up 70% since January], for the growing biotech company Amgen (NASDAQ: AMGN) [down 13% for the year]. Not to mention the inclusion of (NYSE: CRM), a company that I doubt, even the most experienced investor, knows what their business does. (At least it’s up 14% year-to-date!)

Regardless of the changes, the Nasdaq 100 is up 36% on the year, while the Dow lags behind with a 26% gain (the Dow is in SHAMBLES!)

So what’s the problem with proclaiming the Nasdaq 100 as the end-all, be all, indicator of economic growth for years to come?

Chapter 4: Perfection

As the pandemic has pushed our economy into a more digitized world, the recent additions of Airbnb (ABNB), Datadog (DDOG), Fortinet (FTNT) Lucid Group (LCID) Palo Alto Networks (PANW) and Zscaler (ZS) are meant to modernize the index and reflect the current state of business.

The problem arises when you realize that, four out of the six included companies are currently unprofitable, and one of the companies (Lucid) barely has $4 million in revenue for the year. You heard me, million. That didn’t stop investors from stooping a $60 billion valuation on the company! Then again, wasn’t Tesla, a highly unprofitable startup at the time, incorporated into the Nasdaq 100 in 2013? (Look how that turned out.) Heck, even Workday, inc. (NASDAQ: WDAY) is still yet to make a profit!

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Tesla CEO, Wario Musk, on trial for lying about his company’s profitability.

In a way, the inclusion of Lucid Group perfectly sums up the economic climate. Hype and speculation. Maybe the Nasdaq 100 is the best indicator of stock market performance.

In summation, the Dow has too few companies to be considered the best indicator of stock market performance. Conversely, the S&P 500 is overly diversified and lacks some of the younger and fast-growing companies that drive the massive market returns these days. The Nasdaq 100 is a great indicator for performance in this low-interest rate environment, but will it hold once the Fed implements rate hikes and suppresses liquidity?

History doesn’t repeat itself, but it often rhymes.

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