The United States economy is slowly but surely improving. With higher expectations for growth comes renewed optimism in the stock market. Over the last 6 years the private sector has added about 15 million new jobs. And just last month the unemployment rate fell to 4.6% for the first time in nearly a decade. Not all jobs are created equal however. There seems to be a trend of workers losing full time employment while part time jobs are on the rise. Furthermore the service sector and other lower income jobs are growing at a faster pace than manufacturing or other high quality jobs. Despite the mixed results of the jobs numbers in recent months, the Federal Reserve has decided to raise interest rates last week anyway. The Chair of the FOMC, Janet Yellen, mentioned that the hike was “a reflection of the confidence [they] have in the progress the economy has made and [their] judgement that progress will continue.” She further explains that the “economy has proven to be remarkably resilient.”
Historically speaking, in the short term, the stock market indexes and the general economic should have very little to no correlation in their movements. Part of this is because major indexes do not track the entire stock market. For example, the Dow represents 30 large stocks, while the S&P500 holds 500. But both of these indexes leave out the mid cap and small cap companies that form a large chunk of the overall stock market, which is comprised of thousands of individual companies.
There are a number of ways that companies can be weighted in a stock market index. Sometimes they are all given equal weighting. This would mean that a small move in the price of a relatively small stock would have the same effect on the index’s value as the same small move in the price of the largest stock in the index. Other equity indices are weighted by capitalization. It is calculated by simply multiplying the number of shares a company has outstanding by its market price per share. So if one company is worth twice as much as another company, then the first stock would receive twice the weighting in determining the index.
However, the Dow Jones Industrial Average is an index that is structured somewhat in an odd manor. It weighs each company based on their share price. So a stock that is trading at $50 would hold five times the influence as another that’s trading at $10 per share. It doesn’t matter what the market cap or size of each company is. So theoretically a smaller company could have a lot more weighting than a larger company, despite having a much lower market value. In the end, whoever designs the index decides how the index should be weighted.
There remains one more week of stock trading before the end of the year. With today’s closing at 19,933.81, the Dow requires just 67 points more to reach the 20,000 milestone. There’s a better than 50% chance the Dow will reach 20,000 next week, given its current upward momentum and the possibility of a Santa Clause rally. Often during the week between Christmas and New Year’s Day, there is a surge in the stock markets. This phenomenon known as the Santa Claus rally may be caused by happiness around Wall Street, workers investing their Christmas bonuses, and tax considerations.
At the end of the day we should remember that crossing a hypothetical mark like 20,000 for the Dow has no real fundamental importance. At least not any more than 19,999 or 20,001. Traders and investors like to see nice round numbers, but it’s mostly just a psychological milestone.