By Ulvi Hagverdi
Your commercial awareness dose!
Do you want to benefit from the general growth of the stock market? How about eliminating the risk of being exposed to significant share price depreciation of a stock that you are holding? In that case, investing in indexes might be the right path for you!
In simple words, indexes (also known as indices) are global financial instruments that allow you to own small pieces of a wide variety of companies as a single stock, usually from different industries. This technique enables you to increasingly diversify your portfolio, meaning that owning companies from various sectors and backgrounds minimises the risk of your investment going down in case one single industry makes significant losses.
A common example would be the equity index of the S&P 500 – an index that measures the stock performance of the 500 biggest public US companies, which can be purchased for $3,425 at the moment. Another popular equity index is Dow Jones Industrial Average that indicated a stock-price-index of 30 large public companies listed in the USA.
In the UK, the Financial Times Stock Exchange Index enables you to invest in the largest 100, 250 and 1000 companies listed on the London Stock Exchange. Similar indexes can be found for most major economies, from Japan to Spain. Indexes can also be solely based on certain industries. For example, by owning a stock of Nasdaq-100, you will benefit from the overall growth of the most technological and Internet-related reputable companies listed in the US.
Nevertheless, despite their robust diversification features, owning indexes do not always prevent investment losses. The sudden stock market drop during the Covid-19 outbreak and the 2008 Financial Crisis can be excellent examples for the abovementioned statement .
The current pandemic inevitably has a strong negative impact on most economies and businesses, and most governments got themselves into historically high debts. An almost 33% shrinkage was observed in the US economy, while revenues plunged by half for energy firms and more than a quarter for businesses manufacturing durable goods.
Despite all these developments, the latest growth of the US stock market appears to be contradictory to the current economic climate. The S&P 500 and Nasdaq 100 reached all-time highs in August, while Dow Jones 30 also recorded notable growth. Although all of these three indexes faced a sudden decline recently, still a significant proportion of the investors firmly believe in further growth of the US stock market.
But what are the factors triggering this significant growth amid such unprecedented and volatile times?
Firstly, it needs to be noted that returns from safe assets such as treasury bonds and savings accounts have been crumbled due to low-interest rates. Thus the investors have poured all of their savings to equities. Secondly, the fact that Food and Drug Administration approving the use of convalescent plasma (a potential treatment for Covid-19 patients) and progress in different vaccines worldwide gave an instant rise to investors purchasing a wide range of stocks. This rise for demand eventually was reflected in the stock market.
The performance of some significant individual US stocks also played a crucial role. Apple’s and Tesla’s recent stock splits (where a company splits its every stock to “a few pieces” so that it appears cheaper to investors and enhances the demand) enabled more investors purchasing their stocks that led to Apple being the first company in the history to pass $2 trillion valuation (yes, trillion!) and Tesla’s valuation soared to more than $400 billion. In the meantime, the world’s richest man – Amazon CEO Jeff Bezos’s net worth hit $201 billion, given Amazon’s recent share price increase.
However, this historical path of recent developments may memorise some of our older readers a very economically important event – dot.com bubble! A bubble happens when the item’s value rise far above from its real net worth. Dot.com bubble was a stock market bubble in the late 90’s, where the investor community pumped overflowing amount of funds to technology and Internet-related start-ups and newly listed companies, without taking necessary investment considerations such as the price-to-earnings ratio.
This excessive reliance resulted in a stock market bubble, where substantial companies such as Pets.com declared bankruptcy and even today’s e-commerce giants such as Amazon and eBay recorded terrifying losses but managed to survive.
In conclusion, it can be confidently stated that the economic outlook remains relatively positive in the US, while some significant companies’ value growth is disproportionate their profit margin. A potential FDA-approved Covid-19 vaccine is likely to inflate the stock market further and increase the chances of another bubble. In the end, one has to necessarily bear in mind that the stock market is not always the indicator of the general economy – its trend is mainly impacted by the investors’ behaviour and the stock price speculations.
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