Why The Dow Is Beating The S&P 500 & Nasdaq

It's no secret that the stock market jumped after Donald Trump's surprising victory in the U.S. presidential elections last week. The promise of lower taxes and regulations, as well as increased spending on infrastructure fueled what many have called the "Trump rally" in stocks.

But depending what index or ETF you look at, the story of just how well stocks have done since the elections can vary quite a bit. The SPDR S&P 500 ETF (SPY), for example, rose by 1.2% in the period between Nov. 8 and Nov. 14. SPY tracks the S&P 500, which is the most widely followed U.S. stock market index by investors.

SPY's rally put it back to where it was trading in September and October, but it fell just short of its all-time high set in August.

That's in contrast to the SPDR Dow Jones Industrial Average ETF (DIA), which climbed to a record high on Monday, and rose by 2.9% in the post-election period. DIA tracks the Dow Jones industrial average, which is perhaps the most recognizable stock market index for the layperson.

The S&P 500 and the Dow Jones industrial average are two of the three stock indexes frequently quoted by the financial press. The other is the Nasdaq Composite, an index tracked by the Fidelity Nasdaq Composite Tracking Stock (ONEQ). Since the election, ONEQ has been a relative laggard, gaining only 0.6%.

Returns For SPY, DIA, ONEQ Since Nov. 8

Index Construction Dramatically Different

The variation in the performance between the big three indexes and the ETFs that track them isn't unusual, but in light of the heightened focus on stocks by everyone in the country following the elections, it's worth explaining what's going on.

The three indexes are each constructed very differently. The S&P 500 is an index comprising the 500 large-cap U.S. companies selected by committee. Stocks within the S&P 500 are weighted by market capitalization, which means that larger companies get a larger weighting in the index.

Meanwhile, the Dow Jones industrial average measures the performance of 30 committee-selected blue chip companies. With only 30 stocks in the Dow, it's an exclusive index typically comprising large, household names. Importantly, the Dow is a price-weighted index, so companies with higher stock prices get the largest weighting in the index, regardless of their market capitalization.

Then there's the Nasdaq Composite, which measures the performance of all stocks listed on the Nasdaq stock exchange. The Nasdaq is a market-cap-weighted index.

YTD Returns For SPY, DIA, ONEQ

Sector Weightings Drive Relative Performance

Given how differently the big three indexes are constructed, it comes as no surprise that their performance often varies. The S&P 500, which captures approximately 80% coverage of available market capitalization of the entire U.S. stock market, is arguably the best index of the three when it comes to measuring the performance of the U.S. stocks broadly.

The Dow's much more limited scope and arbitrary price-weighting scheme make it an inferior representation of the U.S. stock market. Likewise, the Nasdaq's focus on stocks listed on a single exchange make it a poor gauge of the market.

That said, the post-election performance of the three indexes has nothing to do with how well they capture the broad U.S. stock market. Rather, it has to do with their sector makeup.

The largest sector within the S&P 500 is technology, with a 20.6% weighting. That's followed by financials, health care, consumer discretionary and industrials.

S&P 500 Sector Weightings

For the Dow, industrials are at the top, with a 20.2% weighting, followed by financials, tech, consumer discretionary and health care.

Dow Jones Industrial Average Sector Weightings

For the Nasdaq, tech dominates, with a 43.1% weighting. Consumer services and health care trail far behind, with a 20.9% and 13.4% weighting, respectively. Financials and industrials are much smaller still.

Nasdaq Composite Sector Weights

Since the elections, tech has been a poor performer amid concerns that Trump's policies may be detrimental to the industry. With its massive weighting in tech, it's clear to see why the Nasdaq has underperformed.

In the case of the S&P 500, tech performance has been a drag, but it's been somewhat offset by the surge in the financial sector, which makes up the second-largest chunk of the index.

Of the three indexes, the Dow has the smallest weighting in tech and the largest weighting in financials and industrials, which explains the index's outperformance since the elections.

Contact Sumit Roy at [email protected]