Empowered Investor

Standard and Poor

Standard and Poor's Corporation (S&P) is an investment service that tracks and publishes the ratings of corporate bonds and common stocks. S&P also provides various other investment and research services.

An Index

The trend of the stock market is followed by investors in terms of several indices, such as Dow Jones 30, S&P 500, etc.

Let us examine how an Index is constructed. Consider stock AAA that has a price of $4 and 10 million outstanding shares. By multiplying 10 million by $4, we get AAA's market capitalization as $40 million. Consider two other stocks - BBB with capitalization of $35 million and CCC with capitalization of $25 million. If we want to construct an index consisting of AAA, BBB, and CCC, then in that index, AAA, BBB, and CCC would make contributions of 40%, 35%, and 25%, respectively. Thus, the contributions or weightage of the stocks in the index are proportional to their market capitalization.

S&P 500 Index

In 1923, S&P introduced an Index of 233 companies. Currently, the Index contains 500 companies. These companies are not the 500 largest in terms of market capitalization, but are the leaders in important industries in the US economy. S&P500 is possibly the most widely followed Index in the market. S&P500 represents 75% of the total market capitalization of all the companies traded at the New York Stock Exchange and 70% of all stocks traded in the US.

Industries

An industry is a group of companies with very similar primary product or service. A few examples of industries are: iron and steel, waste management, restaurants, beverages, hospital management, oil and gas drilling, life insurance, computer software and services. Standard Industry Classification (SIC) system provides a list of industry classification. However, this classification is somewhat cumbersome and long. A more compact and accepted classification is done by S&P. The S&P classification contains 90 industries.

Sectors

A sector is a collection of industries with similar characteristics. S&P classification consists of 10 sectors.

In the Table below, the S&P classification of sectors and industries are shown. In this Table, some of the details of the classifications are excluded for brevity. Visit S&P's Web-site for more detail.

On 22 December 1998, the American Stock Exchange introduced a financial instrument that made sector investing easy. These instruments are called Select Sector Standard and Poor Depository Receipts or in short, Sector SPDR's. These are nicknamed as "spiders" in the financial circle.

There are 9 spiders that represent the 10 sectors of S&P500. All 500 companies in the S&P500 are represented in these 9 spiders. Each spider consists of several industries.

The spiders operate somewhat like a mutual fund, i.e., the money pooled from a large number of investors is used to buy shares of the companies within a spider. The spiders have a low expense ratio. The advantage of the spiders is that you can have ownership in a large number of companies by investing a small amount of cash. The spiders do not need a manager for buying and selling shares or for making investment decisions, because the numbers of shares of various companies in the spider are simply controlled by the size of the market capitalization of the companies. The price or net asset value (NAV) per share of spiders is determined in a manner similar to the NAV of a mutual fund.

The major differences between a spider and a mutual fund are: (i)Shares of a spider are bought and sold in the open market. (ii)The dividends earned from the shares in a spider will be deposited as cash in your brokerage account, because spiders do not have automatic dividend reinvestment plan. (iii)You cannot make small, periodic, automatic investment in a spider, as you could in mutual funds. (iv) You pay a brokerage commission when you buy the shares of a spider.

As there are 10 sectors and 9 spiders, there is no one-to-one correspondence between the spiders and the sectors (shown in Table I). In Table II below, the composition of the spiders is shown. The symbols of the spiders, in this Table, are links to the web-site of American Exchange where you will get an elaborate description of the spiders.

Identification of profitable spiders can be done in three steps - (i) assessing the trend (continuation or reversal) of the total return of a spider, (ii) tracking the performance of the sectors underlying a spider, and (iii) timing your buy and sell decisions by using technical analysis.

Trend of Total Return

The total return matrix of the spiderds for the 7-days, 30-days, and 1-year periods are given in the table below. The attractive spiders are shown in green.

Sector Performance

The Smartmoney.com web-site tracks the performance of sectors. The screen for evaluating sector performance is shown in the Figure, below.

You can track the performance of a sector for the past one month or one year on the sector tracker screen. The simple principle that one can use in identifying profitable spiders is - buy the spiders that contain sectors with uniformly profitable (green bars) industries. In the following Table, this simple strategy is shown.

Technical Analysis

Make your buy sell decisions based on technical analysis using Prophet Finance Javacharts.

Other pooled investments that are designed to closely track the price and yield of an index:

• DIA - Tracks the Dow Jones Industrial Average.
• SPY - Tracks the S&P500.
• QQQ - Tracks the NASDAQ-100 Index.
• MDY - Tracks the S&P400 Midcap Index.