It is mentioned daily in newspapers, on television and on financial (but not only) websites: it is impossible not to have heard of the S&P 500. But what is it, exactly? And why is it so important for the global equity market?
Let's start with the basics: the S&P 500, short for Standard & Poor's 500, is a market capitalisation-weighted index of the 500 largest publicly traded companies in the United States. These companies make up about 80% of the total value of the US equity market. It is therefore not surprising that many consider it the benchmark index par excellence, not only in the US but also globally.
Currently, the S&P 500 includes 503 components because three companies, like Google, have two listed share classes. Considered one of the best indicators of US economic performance, the S&P 500 is also a key barometer for global finance.
But it is not the only one: the S&P 500 is in fact part of a family of indices. For example, there is also the S&P MidCap 400, which includes mid-capitalisation companies, and the S&P SmallCap 600, which includes smaller companies. Together they account for over 90% of all US capitalisation.
To join the S&P 500, a company must be listed on an American stock exchange (on the New York Stock Exchange or NASDAQ), be headquartered in the US and show positive earnings for the last four quarters. But that's not all: there are other, more technical requirements to be met in terms of liquidity and especially market capitalisation (or market cap).
The capitalisation of the 500 companies included, i.e. the stock price multiplied by the number of shares on the market, tends to vary over time and amounts to several billion dollars. Other key requirements include that the proportion of shares in free circulation (the so-called public free float) must be at least 50%.
It all began in 1923, when the Standard Statistics Company and Poor's Publishing decided to launch an index with 233 companies (which fell to 90 three years later). The Standard Statistics Company was in charge of rating mortgage bonds, while Poor's Publishing offered advice for investors in the railway industry. A few years later, in 1941, the merger between the two companies led to the birth of Standard & Poor's. Later, in 1957, the index expanded to include 500 companies.
There is a good reason why the S&P 500 is one of the most highly rated US indices: it focuses on the largest companies and its composition is dictated by market trends. The S&P 500 uses a weighting method that is based on assigning a higher percentage to companies with the largest market capitalisations. This is because, quite simply, these companies have a greater impact on the overall value of the index.
Currently, the top five companies in the S&P 500 account for a quarter of the entire index and are:
As can be guessed from this list, the index is highly concentrated on the tech sector (almost 30%), followed by the financial and health sectors. This is useful for us to get a general idea not only of the economic composition of the US, but also of trends in the world economy.
The S&P 500 index is based on a weighted calculation system that takes into account the 'weight' of each company, determined by its market capitalisation. This weighting system provides valuable information to investors, as it shows the relative weighting of each company in the index. For example, Apple currently has the highest weight in the index, at over 7%.
Information on the total market capitalisation for the S&P 500 and for individual companies can easily be found on the S&P Global website and other financial information portals, without having to calculate it yourself. Thanks to the weighting, you can get an idea of the impact of a security's performance on the index. In general, for the same price movements, a company with an 8% weighting will tend to have a greater impact than a company with a 4% weighting.
The performance of the S&P 500 over time has been influenced by numerous political and economic events. Since the index was born almost a century ago, it has undergone several fluctuations. In the 1950s, the economic boom generated positive results on the equity market. In the 1960s and 1970s, however, inflation and energy crises led to a fall in prices. This decline was mitigated in the 1990s by the great rise of the technology sector.
The index suffered significant declines as a result of economic crises and asset bubbles. The dot-com bubble burst in 2000, leading to a significant decline. Subsequently, in 2007, the crisis in the real estate sector caused another significant drop in the index. In 2020, the COVID-19 pandemic, an exogenous shock, caused a rapid and dramatic collapse of the index. However, on each occasion, the S&P 500 managed to recover, demonstrating the resilience of the US equity market.
It is important to note that, like any other index, the S&P 500 is subject to unpredictable risks and market fluctuations. However, its ability to rebound after periods of crisis is a testimony to its long-term solidity.
While not a tool for predicting the future, studying the past provides an important basis for establishing realistic expectations about risks and possible changes in returns.
In this graph, taken from the blog A Wealth of Common Sense, we see how over the past 30 years, the S&P 500 has generated an average annual return of 10%. To read the graph, simply choose a starting year, go down the number of years, and the corresponding square will show the annualised return from that starting point. For example, starting in 1993, the annualised return over 9 years was 14%. This type of visualisation helps to understand how the variability of returns decreases as the time horizon increases, highlighting the importance of a long-term investment approach.
The first thing to do if you are considering investing in the S&P 500 is to understand what your attitude is. As we have seen, the index is composed of some of the most important and solid companies in the world: if you think you want to invest in the global economy, with a North American-oriented focus, this could be the perfect solution for you.
Furthermore, you should know that those who choose to invest in the S&P 500 index can do so in one of two ways. The first is much more laborious and expensive (also in terms of fees), since it consists of directly buying shares for each company that makes up the index.
The second way is through investing in ETFs: passively managed investment funds that faithfully replicate the performance of an index such as the S&P 500, offering automatic diversification and significantly lower costs than traditional funds.
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