The NASDAQ Composite Index
is Useless
NASDAQ vs. S&P 500
Investors who watch the financial news networks have been inundated by
commentary on the NASDAQ Composite Index this year. This index is gaining
headlines due to it approaching an all-time high back in early March and ending
the quarter with an impressive gain of 3.79% versus the S&P 500 at 0.95%.
Due to the attention from the media and the strong relative performance against
the S&P 500, many investors, particularly conservative ones, are frustrated to
see their returns well below that of the NASDAQ.
However, there are three main reasons why the overwhelming majority of
investors should ignore the NASDAQ altogether: (1) Composition, (2) Volatility,
and (3) Applicability.
Let’s begin with a comparison of the composition of the two indices. The
NASDAQ Composite Index includes all companies listed on the NASDAQ Stock
Exchange, which currently stands at more than 3,000 listed stocks. However,
these companies typically represent higher growth ones and are concentrated
into specific sectors like technology and biotech.
The S&P 500 includes 500 companies from all sectors of the economy with
stocks listed on either the New York Stock Exchange (NYSE) or the NASDAQ
Stock Exchange. The companies in the S&P 500 account for roughly 75% of the
value of all U.S. equities and is therefore well-regarded as the most
representative index for large-cap U.S. equities.
The differences in composition explains why the NASDAQ Composite
outperformed the S&P 500 by such a wide margin in the first quarter. For
example, energy stocks were hit hard as the price of oil continued to fall, and the
S&P 500 has a much higher proportion of energy stocks, which created a drag
on the index. Furthermore, high growth sectors like biotech remained strongly
in favor.
Simply put, the NASDAQ Composite Index is nowhere near a representative
example of the overall U.S. equity market because it’s concentrated towards high
growth stocks in specific sectors.
NOTE: Many investors also consider the Dow Jones Industrial Average (Dow) to be analogous to
the S&P 500. However, the Dow only tracks 30 companies across fewer sectors versus the S&P
500. Therefore, the S&P 500 is still considered a more reliable gauge of the broader U.S. equity
market because of the sheer number of companies and indices that it tracks.
The second reason why investors should ignore the NASDAQ goes back to one
of the most fundamental principles of finance. The chart below show precisely
what can happen to the NASDAQ during times of market stress.
In March and April of last year, the NASDAQ Composite (dashed line) fell 8.22%
vs. a drop of only 3.10% for the S&P (solid line). Go back over the last 20 years
and investors will see that this type of heightened response to market dips in the
NASDAQ is the norm.
Simply put, higher returns are only possible by accepting higher amounts of risk
and/or volatility, and only those investors who can stomach major swings should
consider tracking the index.
The third reason why investors should ignore the index is because professionals
also ignore it, in that practically no money managers use the NASDAQ as a
benchmark.
Based off a universe of just under 4,500 funds that are available in the US, a total
of 759 (approximately 18%) are benchmarked against the S&P 500, whereas
only 32 (less than 1%) are benchmarked to the NASDAQ Composite or NASDAQ
100 (a smaller universe of the 100 largest companies on the NASDAQ Stock
Exchange).
Simply put, the NASDAQ is an index that may appear interesting to the media,
but barely any mutual funds, exchange traded funds, or fund of funds consider
the index to be relevant, and neither should you.
Implications for Investors
The single most desired characteristic of an investment is its ability to grow over
time, and those investments that offer the opportunity to grow like weeds tend to
garner more attention from the media because the stories are often far more
exciting than conservative ones.
Investors can only profit from hyper-growth stocks if they are willing to accept
hyper-risk. It’s that simple, and it’s a concept taught on day one of any finance
class. For every high-flying tech stock that succeeds over the long run, there are
dozens upon dozens that go nowhere and/or simply fail.
The bottom line is that even though the NASDAQ is an index regularly quoted on
TV right next to the S&P 500, it does not provide broad U.S. equity market
exposure. The index’s tilt towards more risky industries and characteristics make
it a near useless barometer for a conservative investor.
NASDAQ
NASDAQ is a market-value weighted index that measures all NASDAQ domestic and foreign common
stocks. You cannot invest directly in an index.
S & P 500
The Standard and Poor’s 500 is an unmanaged, capitalization weighted benchmark that tracks broad-based
changes in the U.S. stock market. This index of 500 common stocks is comprised of 400 industrial, 20
transportation, 40 utility, and 40 financial companies representing major U.S. industry sectors. The index is
calculated on a total return basis with dividends reinvested and is not available for direct investment.
This commentary is not intended as investment advice or an investment recommendation. It is solely
the opinion of our investment managers at the time of writing. Nothing in the commentary should be
construed as a solicitation to buy or sell securities. Past performance is no indication of future
performance. Liquid securities, such as those held within DIAS portfolios, can fall in value. Global
Financial Private Capital is an SEC Registered Investment Adviser.