The Standard and Poor’s 500 is the most watched and followed equity index and is the major benchmark against which most hedge funds, fund managers and investors measure their performance against.

Here is a short breakdown of its history:

• In 1923 the Composite index was launched to track 233 American stocks. The number of stocks was increased over the following years. 
• The S&P 500 index in today’s form, including 500 large American companies registered in stock exchanges, goes back to 1957.
• Today the index is considered as the most accurate indicator of the U.S. equity market and is commonly used as the benchmark to measure the performance of individual stocks, other stock indices, portfolios or any other assets.

Technically, the weighting inside the S&P 500 index is according to the respective market capitalization of each company, which summed up represents a huge portion of the entire market value of the entire American stock market.

In contrast, the Dow Jones Industrial Average index (DJIA) is a price-weighted index, which does not take into consideration how much total value each included company represents. This is seen as the main reason why most professionals today see the S&P 500 as a better gauge of the equity market and it is also the reason, why it has overtaken the role as the best representative index of the U.S. stock market.

Some other notable features of the S&P 500 index are:

• Over time companies can be dropped and new companies can be added. This process depends on a committee that evaluates several factors.
• The market capitalization of the S&P 500 is about $35.1 trillion, while the total U.S. equity market cap is $40.9 trillion. Thus, the index represents about 85% of the American stock market.
• Since the contribution to the index is determined by market size, the price movements of large companies have a much higher impact than price changes of smaller companies.
• The statistics are as follows:
  • The top 5 companies represent slightly more than 20% of the index:
    • Apple (AAPL) → 7.1%
    • Microsoft (MSFT) → 5.8%
    • Google (GOOGL) → 3.7%
    • Amazon (AMZN) → 3.4%
    • Tesla (TSLA) → 2.2%(As of October 12th, 2022)
  • The top 40 companies represent about 50%.
  • The remaining 460 companies represent the other 50%.
  • Here is a pie chart that gives a graphic idea about the weighting:

• $100 dollar invested in 1957 was worth about $66,387 at the end of 2021 (assuming that all dividends were reinvested).
  • A yearly return of 10.51%
  • Or a total return of 66,287.09% (The power of compounding!!!)

Here is the chart that shows the performance (recessions are indicated in grey):

Or here is the same chart, but on a logarithmic scale, to provide a better idea about how the tracked companies performed over time percentage-wise:

Another insightful way to look at it, is to not only look at individual companies, but to also analyse the sectors, that contribute to the index valuation, and their relative performance :

As can be seen, the Technology sector is by far the largest (about 30%) and has contributed (together with the Communication Services sector and Consumer Cyclical sector) the most to the overall decline so far this year. On the other hand, the Energy sector, which has seen enormous gains, has not had such a big impact on the overall index, since it only accounts for about 4% of it.

Consequently, when analyzing the movements of the S&P 500, it is important to bear in mind that a) it is largely dominated by just a few companies and b) that different sectors might also behave vastly differently and that this is not necessarily captured by the index.

More generally speaking, a rise in the S&P might indicate:

• A healthy economy with new innovation and rising productivity.
• Global growth and globalization:
  • leading to export opportunities as well as more specialization and improved value creation across international supply chains.
  • Allows foreigners to increasingly invest in the U.S. market.
• Consumer & Investor confidence in the future.
• More risk appetite (selling bonds, buying stocks)
• An expansion of the broad money supply (more dollars chasing the same amount of stocks) → arguably the most significant contributor to the stock market appreciation in recent years.

International Importance of the S&P 500

The U.S. population represents 4.25% of the world population.

The U.S. GDP makes up about 24% of the total global GDP.

U.S. equities account for 40.9% of the global equity market:

While the U.S. GDP is about 30% higher than that of Europe and roughly 60% higher than that of China, its stock market valuation dwarfs both of them by 400%.

There are numerous reasons for this:

• The most influential reason is probably that the US dollar has the status of being the reserve currency. According to the Triffin Paradox, this is why the growing global economy has an increasing demand for US dollars. This in turn also partially explains, why the U.S. have been running an increasing trade deficit over many decades (starting in 1976). The trade deficit means that foreigners hold an increasing amount of dollars which they have to reinvest in USD denominated assets — hence, mainly Treasuries or stocks.
• It is a vibrant and open stock market with deep liquidity, a lot of globally available information and little restrictions to participate.
• The U.S. stock market has also become regarded as the best regulated and most secure stock market over time, also a reason to attract international investments.
• Investing in stocks has always been a main place to allocate capital in America, whereas in most other countries (for example my home country Germany), it just recently has become a more popular way to invest savings.
• Most major innovations over the past 100 years have come from U.S. companies.
• There is a general stock market correlation across the globe, with the U.S. stock market being the leading indicator.

Thus, the S&P not only is an important indicator for the U.S. market, but bears international importance.