The S&P 500 is an index that tracks about 500 of the largest U.S. companies by market cap. It’s said to cover almost 80% of the total value of the US equity markets.¹
The importance of the S&P 500
The S&P 500 is a value-weighted index, which means that the value of a stock in the index is based on its market cap. The value of a company is a product of the price and number of shares available.
The S&P 500 is considered to be a barometer of the US economy. There has been a historical correlation between the index rising when economic growth is strong in the US. On the other hand, a crash in the price of the S&P 500 has often signaled the onset of a recession, although this isn’t always the case. Many index and mutual funds are based on the index's constituents. These funds are a proxy to investing in the overall equity markets, and often the return of these funds is often compared to the yield of this index to evaluate the skill of a fund manager. Information Technology (28.7%), Healthcare (13.1%), and Consumer Discretionary (12%) are the top three sectors in the index.²
Since it only covers the top 500 companies, the S&P 500 generally does not consider medium-cap and small-cap companies. At times, the index may not accurately portray the economy. Instead, it could be considered a barometer of investor enthusiasm.
Example
The contribution of tech stocks in the S&P 500 index has constantly risen over the past decade. This, in turn, has led to a rise in the market value of IT companies since the index is a popular benchmark for many passive funds. Companies like Apple, Microsoft, Amazon, and Alphabet have been top holdings in the index for some time, given their market capitalizations compared to the rest of the ~500 companies.³
Sources
1. S&P 500.
2. How to invest in the S&P 500. Investopedia.
3. The five biggest tech companies now make up 17.5% of the S&P 500 — here’s how to protect yourself. CNBC.
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