Meltdown 101: Why the S&P 500 index is important

The ups and downs of the Dow Jones industrial average may get most of the attention, but there's another stock index you should be watching: the Standard & Poor's 500, which offers a broader sense of how stocks are doing and determines the performance of many mutual funds.
Many market pros keep an eye on the Dow, of course, but when they need a close-up look at the U.S. market they turn to the S&P 500. Investors rely on it as a barometer for the economy, and it serves as the market's primary benchmark — trillions of dollars in investments mirror its moves, and the performance of many investment funds is measured against it.
Here are some questions and answers about the S&P 500, including what it says about the state of the economy.
Q: What is the S&P 500 index?
A: It's a grouping of the stocks of 500 large companies that's designed to give a big-picture view of the U.S. stock market. It reflects about 75 percent of the value of the U.S. stock market. The index is run by Standard & Poor's, which is best known as a credit rating agency.
Data for the index's predecessors extend back to 1923, so it gives market analysts a long history to review for clues about how stocks might move in the future. It once included as few as 90 companies, but was expanded to 500 in 1957.
Q: What makes it important?
A: Everyday investors are more likely to have their money tied to the S&P 500 index than the Dow. About $1.5 trillion in investments mirror the moves of the S&P index and $4.9 trillion in investments are measured against it; the Dow, by comparison, has about $32.6 billion in investments that track it.
Jeffrey Kleintop, chief market strategist at LPL Financial in Boston, said he's been getting more questions from investors about the S&P 500 index in the past year as the stock market tumbled.
"The Dow used to represent 30 strong companies that could be bought and held forever and that whole concept is rapidly fading if not gone completely," he said.
In an illustration of this, multiple longtime Dow companies have been dropped from the index during the recession. This week, Dow Jones & Co. said it was dumping General Motors Corp., which filed for bankruptcy protection, along with Citigroup Inc., which was dropped because it's less of a publicly traded company than it used to be — federal bailout money has made the government a major shareholder.
In the fall, the Dow dropped insurer American International Group Inc. after bad bets on mortgages threatened to topple the company and the government pumped in billions of dollars to keep it afloat.
Fans of the Dow's simplicity point out that it moves the same way as the S&P 500 index 95 percent of the time, but Kleintop said the S&P is quicker to factor in new forces in the economy.

"A lot of new industries and sectors get their representation in the S&P 500 well before they show up in the Dow," he said. The S&P 500 is also important because, as with other indexes, its moves can offer some idea of how the economy is expected to fare. A sustained slide in the S&P 500 can signal that investors expect the economy to slow. The S&P 500 began sliding in October 2007, months ahead of the recession's start in December 2007.
Q: How is the S&P 500 set up?
A: It is divided into 10 groups that represent the leading industries in the U.S. economy. For example, there are industrial companies, like General Electric Co., and information technology companies, like Microsoft Corp.
Q: Why do the groupings matter?
A: Investors can look at how the stocks of different types of companies are performing, which can provide clues about the health of the economy.
When the economy is wheezing investors tend to flock to businesses that are seen as less vulnerable, such as health care stocks, like Johnson & Johnson, and makers of consumer staples, like Procter & Gamble Co. These sectors tend to be more resilient because they provide products and services that people always need, regardless of the economy. On the other hand, retailers, like Macy's Inc., might fall out of favor if investors worry consumers will be cutting back.
Q: What determines how the index moves?
A: The S&P 500 doesn't simply rise or fall based on changes in share prices. Based on price alone, Google's $432 shares would have more pull than Exxon Mobil Corp.'s $72 shares. The index also takes into account how many shares of a company can be traded in the marketplace. So Exxon, with more shares floating around, is valued at $355.8 billion compared with $135.3 billion for Google — and thus has far more influence over whether the index goes up or down. In contrast, the Dow Jones industrial average is moved most by those of its 30 stocks with the highest price. So in the Dow, IBM at $106 has greater say in what the blue chips do than does Exxon at $72.
Q: I know that a 200-point drop in the Dow doesn't feel good. What's considered a significant move in the S&P?
A: Analysts caution against reading too much into any one day's moves. But to get a good sense of what the market does, focus on percentages. A 2 percent move in a day is a big shift.
Q: How are companies picked for the index?
A: An S&P committee considers publicly traded U.S. companies worth at least $3 billion in the eyes of the stock market. There are many considerations, including how readily a stock can be traded. Warren Buffett's Berkshire Hathaway, for one, is plenty big enough to make the cut, but S&P has left it out of the index because it considers the company too cumbersome to trade. The reason: Its shares are priced at $89,500 apiece.
Q: What is the S&P 500 index telling us about the U.S. economy right now?
A: The index is still way down from its peak in October 2007, but it's surged about 40 percent from a 12-year low in early March — meaning it's quickly made up almost exactly half of what it's lost during the downturn. The three-month rally translates to a gain on paper of $2.4 billion — though the loss since the peak still totals $5.6 billion.

The gains show that investors are becoming more confident about an eventual recovery in the U.S. economy. Still, that doesn't mean the rebound won't be bumpy.

In downturns during the past 60 years, the S&P 500 index has hit bottom an average of four months before a recession ended and about nine months before unemployment hit its peak. So if history repeats itself, recovery may be near — but any growth in jobs may be many months away.