No, don’t worry, there won’t be an exam at the end of this course. But you will have the knowledge to keep up with your friends the next time happy hour turns into an episode of Barron’s Roundtable or the Squawk Box. Whether you’re new to investing or have been in and around the market a while, a quick refresher can be helpful for anyone. In this blog we will walk through some of the basics of the U.S. stock market, take a brief dive into a few of the different indices that make up the market, and expose the potential perils of relying solely on financial news programs like CNBC, Fox Business, and other similar programs for all of your market insights.
The Marketplace – It’s not as complex as you might think
When we think of a “marketplace”, what comes to mind might be a local farmers market or a mall. Hundreds, maybe thousands, of people gathered in one place – buyers, sellers, “lookie loos” – everyone there to participate in the “marketplace.” The stock market is no different, except for being on a much larger scale. The stock market is a bustling marketplace, teeming with investors looking to buy and sell various stocks or securities. It is here that companies raise capital by offering shares, and investors can participate in the growth of these companies by buying and holding those shares until they hopefully gain enough value and then ultimately sell them for a profit. Just as in an everyday marketplace, the stock market experiences fluctuations in prices based on supply and demand, making it an exciting yet risky domain. We call this fluctuation in prices volatility.
Volatility is measured in the stock market based on the Volatility Index (VIX). The VIX is referred to by many as the “fear index” but the VIX doesn’t need to be scary. The VIX is more like a rollercoaster monitor for the US stock market. It measures the market’s expectation of volatility over the next 30 days by analyzing various prices on the S&P 500 index. When the VIX is high, it indicates that investors expect more significant price swings and uncertainty in the market. Think of it as the anxiety level in the financial realm—when it’s low, it’s like the carousel at the state fair, nice and easy, but when it’s high, it’s like a Six Flags roller coaster with drops and twists and turns. The VIX helps investors gauge the current and potential future level of risk and make informed decisions based on market sentiment.
Indecisive about Indices – What should you follow?
To gauge the overall health of the stock market, we turn to indices. Every stock, both in the U.S. and internationally, trades on an index. An index, to keep the marketplace analogy, is just a basket of fruit that gives you an idea of how all the other fruit in the market is doing. In the U.S., the 4 major indices are the Dow Jones Industrial Average (DJIA), the S&P 500, the Russell 2000, and the Nasdaq Composite. Let’s take a quick look at each of these to understand the basics:
- Dow Jones Industrial Average (DJIA): The DJIA is a price-weighted index that represents the stock performance of 30 large, well-established companies across various sectors of our economy. It calculates the average stock price of these companies and creates a single number to reflect their overall performance. Think of the DJIA as your H-E-B shopping cart with 30 popular, household brand items in it. It gives you a quick glimpse into how those specific brands are doing, but it doesn’t include the entire range of products available in the store.
- S&P 500: The S&P 500 is a market capitalization-weighted index that tracks the performance of the 500 largest companies listed on the NYSE. It represents a broader view of the market as it includes companies from multiple sectors of our economy. Imagine walking through Walmart and picking items from different sections of the store like fruits, vegetables, dairy, clothing, etc. The S&P 500 is like a basket filled with a diverse range of products, giving you a more comprehensive understanding of the overall market performance.
- Russell 2000: The Russell 2000 is a market capitalization-weighted index that consists of approximately 2,000 “small” companies. Small is relative as a small cap stock’s market value can range anywhere from $250 million to $2 billion. The Russell 2000 focuses on these smaller companies that are not included in the DJIA or S&P 500. Picture yourself visiting a local farmer’s market where you find unique and specialty products from local vendors. The Russell 2000 is like a shopping list from this market, highlighting the performance of smaller, less well-known companies. It allows investors to explore these smaller players and potentially discover hidden gems as every company starts small – Amazon, Apple, Microsoft – were all small cap stocks at one point in time.
- Nasdaq Composite: The Nasdaq Composite is a market capitalization-weighted index that represents the performance of more than 3,000 companies listed on the Nasdaq stock exchange. It is known for its concentration of technology and growth-oriented companies. Imagine entering a high-tech store, filled with gadgets, electronics, and cutting-edge products. The Nasdaq Composite is like a shopping list for this store, focusing on technology-driven companies. It provides insight into the performance of the tech industry specifically.
Navigating the Hiking Trail of Financial News Programs: Beware of the Talking Heads
Now, let’s shine a spotlight on a different part of the market story: financial news programs. These programs have a knack for turning everyday investors into nervous wrecks, thanks to their incessant focus on short-term market movements and flashy headlines. They’re like a horde of squirrels, constantly scampering around with breaking news, leaving us confused and frantically trying to keep up. Watching financial news programs, and it does not matter what “side” you are watching, can be detrimental to your mental health. They bombard us with a never-ending stream of predictions, “expert” opinions, and market noise. As an everyday investor, it’s easy to get caught up in this whirlwind and make impulsive decisions based on sensationalized stories.
Imagine you’re lost in the forest while hiking and stumble upon a group of other hikers. You can see from a distance that they have all brand new, top of the line gear. This group truly looks the part and like they belong on the cover of National Geographic. You haven’t been hiking all that long and so you’re a bit unsure about the best way forward, but you say to yourself “I can’t afford to miss out on this, they MUST know the way. What if they give me the secret tip to getting out of here faster?” It’s impossible not to ask them for help, they look like experts, so they must be experts. You stop and begin to introduce yourself and before you can even get your first name out, they all claim to know the best way out of the forest and begin loudly shouting contradictory directions at you and arguing with each other about the best way forward. Some tell you to just go back the way you came and quit while you’re ahead, some say you should just stay put with them, no use in doing anything at all, others tell you the way ahead is better than the way you came and keep going. Now, somewhere in there is the right answer for you but you didn’t even get a chance to tell them about where you’re going, where you’re coming from, how experienced you are with hiking, nor how far your scheduled hike is. So, do you trust them blindly and follow their advice? I would wager probably not. Similarly, financial news programs are filled with talking heads, each with their own agenda and biases. It can be extremely difficult to not lean into these programs because they look like experts. They’ve got fancy suits and ties, they speak in complex financial jargon using big complex words, they have graphics, charts, and percentages everywhere, they look the part. And while many on these programs are highly intelligent people and know a lot of good information, their job is not to simply relay that information to you. Their job relies on getting viewers and keeping viewers and in our society today, calmness doesn’t sell. Chaos, fear, and hysteria sell and that is precisely what these programs do. They drum up fear and panic to get people to tune in and stay tuned in. To make the case that these programs are just noise and don’t provide any long term, sound advice, let’s look at a quick case study about CNBC.
Going back to May of 2010, CNBC has aired a program called “Markets in Turmoil” over 100 times – this program is only aired during times when the market has dipped significantly. According to Charlie Bilello, Chief Market Strategist for Creative Planning, every time that CNBC has aired the “Markets in Turmoil” special, the 1-year forward total return from that date for the S&P 500 has been positive every single time with the AVERAGE 1-year return being 40%. So, what does that tell us? Statistics would tell us that with a high level of confidence, it could be said that when this program airs, the market will be up in 12 months. Now, we do not base our investment decisions on when a financial news program airs, but what we would say is that when programs are out there making noise, to stay away from it. Listening in can only lead you down a wrong path and fan the fear flames you may already be feeling. Living your life and not listening in will only make you happier in the long run. The goal in investing is to see your account grow over the long term and live happily ever after, not collect a closet full of “I Survived the Market Crash” T-shirts. Being fearful is not wrong, it’s human instinct. Choosing to live in fear and take in these programs that push your fear to the brink is what is not good.
Mastering Investment Markets: Navigating Ahead with Confidence and Caution
Well, congratulations! That was your Investment Markets 101 Crash Course. Understanding the basics of investment markets is crucial for both new and experienced investors. By familiarizing yourself with the bustling marketplace of the stock market, recognizing the significance of volatility and the role of indices, we hope that you can navigate the world of investments with more confidence. Remember, it is equally important to exercise caution when consuming financial news programs. While they may appear knowledgeable and authoritative, these programs often prioritize sensationalized stories and short-term market movements, which can lead to impulsive decision-making. Just like encountering the group of hikers in a forest, it’s essential to consider your own goals, experiences, and circumstances before blindly following the advice of talking heads. Remember, the true goal of investing is long-term growth and financial well-being, not succumbing to fear and market hysteria. By staying informed and focusing on your own investment strategies, you can strive for a happier and more prosperous future. If you would like to talk more about how BentOak Capital can help you achieve a more prosperous future, please give us a call today!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.