Question

The S&P 500 and the Dow Jones Industrial Average indices are proxies for the broader US stock market. You notice one day that the S&P 500 closed UP by 0.20%, while the DJIA closed DOWN by 0.20%.  

Explain how it is possible for one proxy (S&P 500) to have a positive return while the other (DJIA) has a negative return on any given day. Include in your explanation some names that could have caused this discrepancy. Which return (S&P 500 or DJIA) is more indicative of the 'true market return'?

To facilitate your analysis, please refer to the link below that shows the components of the S&P 500 and DJIA.  Hint: Recall the S&P 500 contains the largest 500 US companies where the weight of each name is proportional to its market value. The DJIA is a price-weighted index comprised of select 30 names representing certain industries.

Answer 1

Dow Jones industrial Average and S&P500 are two indexes that had different basis for their overall representation as Dow Jones is a price weighted index that means that it just includes the the price weighting of top 30 companies in the United State where as S&P500 is the value weighted index of top 500 companies in In The United States so S&P500 is a better reflection of United States economy as it is well diversified and the movements are highly calculated because it is dependent upon the overall market capitalisation of various shares into the economy.

There is a discrepancy in return of both the stock on the same day because of proportion of constituents in respective index is different and the weighting of those stocks are different so if one stock which has the most weight in the Dow Jones will be underperforming, then the Dow Jones will underperform the S&P500 whereas S&P500 is not much dependent upon the movement of one stock because it is a volume weighted index of top 500 company in the United States.

If it is to be exampled, Boeing limited had caused severe downside in Dow Jones on several occasions because Boeing is the major constituent of Dow Jones and any adverse or volatile movevement would reflect into the Dow Jones whereas it would not reflect much into S&P 500 as Boeing is not the major constituent of S&P500.

S&P500 is better index and it is a better indication of overall market return because it includes a large number of companies and it has been VALUE WEIGHTED.