Measuring the Market
- Tuesday, March 28, 2000
Reprinted with permission from World Finance Net IPO Newsletter, written by Alexander Frauenfeld
It has been a crazy market with a lot of volatility so far this year. The Dow Jones industrial average is off 7.8% as of last week, but the tech-heavy NASDAQ Composite Index, despite a mid-March correction, is up about 17.9%. Further volatility is in store for weeks to come as well. So, is this a Bear market or a Bull market?
Investors naturally want to be able to measure the overall market so they can gauge their portfolios performance versus the average. The Federal Reserve also cares about the market because it believes a rise in stock wealth is stimulating too much spending. The issue is deciding just what is going on. Confusion over the market's condition is a dangerous thing.
Fortunately, there is a fairly precise measure available. Since January 1st, the market is close to flat. How do we know this when the most widely watched indices have moved in opposite directions and are showing major gains or losses? By looking at the one widely overlooked index that tracks the performance of the entire U.S. stock market: the Wilshire 5000 Total Market Index, which is just about even for the year.
The Wilshire 5000 Total Market Index is the only stock market indicator that covers the performance of the entire U.S. equity market. The index consists of over 7,000 U.S.- headquartered equity securities, individually weighted by market capitalization. From giants like Microsoft (MSFT) and General Electric (GE) to micro-caps that are one step up from trading on the pink sheets and bulletin boards, the Wilshire 5000 represents them all.
As a total market index, the Wilshire 5000 should be considered the best representation of the U.S. equity market, since it indiscriminately covers the entire domestic market universe. By comparison, the S&P 500 consists primarily of large cap companies (as well as ADRs of international companies). The DOW covers an even narrower segment of the market, consisting of only 30 industrial companies, and it is also price-weighted, meaning that its performance is driven by the performance of higher priced issues rather than by total market cap. Finally, the NASDAQ primarily consists of high growth, technology companies that trade over-the-counter. The constituents in all three indices are represented in the Wilshire 5000.
About the Wilshire
Since its inception in 1971, the Wilshire 5000 has returned 13.7% per year through late1999, almost identical to the 13.8% return for the S&P 500 index over the same period. Over shorter periods, however, the annualized returns can differ by significant amounts.
Although over the long run the Wilshire 5000 has returned roughly the same as the S&P 500, its relative return is impacted by the cyclical performance of small stocks versus large stocks. Given its total market coverage, the Wilshire 5000 is positioned to capture more systemic performance from small stocks than the S&P 500 and will outperform should small stocks rally. The Wilshire trails the S&P 500 when large caps are strong and leads it when, as now, small caps rally.
At the present time, the Wilshire 5000 is trading around 14,200 points. Each point currently equals approximately $1.16 billion in market capitalization, which means public companies in the U.S. are collectively worth about $16.47 trillion.
The Wilshire is Federal Reserve Chairman Alan Greenspan's favorite measure of the market. It gives the clearest signal of the market's collective judgment of what companies are worth, and Greenspan, despite his warnings against irrational exuberance, takes the market's forecasting abilities rather seriously. Plus, the Wilshire 5000 reflects each and every last dollar of stock wealth.
Investment houses and the media have been slower than Greenspan to pick up on the Wilshire 5000s value. If the index is mentioned at all, it is usually after the historic but unreliable DOW, the tech-heavy NASDAQ composite, the large-cap Standard & Poor's 500-stock index, and the small-cap Russell 2000, each of which captures only a certain piece of the overall market.
Investors should seriously consider using the Wilshire 5000 as a benchmark for their portfolios performance. It has a little of everything. As of this year the index was composed of 29% technology stocks, 25% consumer non-durables, 14% finance, 10% materials and services, 9% utilities, 5% capital goods, 5% energy, 2% consumer durables, and 1% transportation. General Motors (GM)? It's in there. JDS Uniphase (JDSU)? That is, too.
Of course, if you are strictly a tech investor, you are better off measuring yourself against a tech index like the NASDAQ. If you really like large caps, the S&P 500 would be an ideal benchmark. But then you have to ask yourself why you are making sector bets in the first place. Modern portfolio theory says you earn the highest risk-adjusted returns by spreading your eggs among many baskets. And that is essentially what the Wilshire 5000 is doing, by using all the companies out there. How much more diversified can it get?
But even if the Wilshire is not your guiding light, it is unquestionably the right index to consult the next time somebody asks you "How is the market doing?"
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