Investors took a pause on Tuesday morning, with major stock market benchmarks easing lower after massive gains over the past two trading sessions. As of 10:30 a.m. ET today, the Nasdaq Composite (NASDAQINDEX: ^IXIC) was down more than half a percent, taking far larger losses than fellow indexes like the Dow Jones Industrial Average (DJINDICES: ^DJI). That's been a trend lately, with the Nasdaq seeing a much larger drop in January than the Dow.
For casual investors, there's often confusion when different indexes don't behave the same way. However, two fundamental differences in the makeup of the Dow and the Nasdaq explain the disparity. Below, we'll go into both of those factors to see how they've played out lately.
1. The Dow doesn't have many Nasdaq stocks
When you look at the broader market, you'll see a roughly even split among stocks listed on the New York Stock Exchange (NYSE) and those on the Nasdaq stock market. If anything, there are slightly more companies that choose to list on Nasdaq.
However, among the 30 stocks that make up the Dow Jones Industrial Average, the two exchanges aren't even close to parity. Nearly two dozen Dow stocks are listed on the NYSE, compared to just seven on Nasdaq.
That split reflects the historical respect that investors gave companies with NYSE membership. Even though Nasdaq has tightened its standards, blue chip investors still seem to value the clout that comes with an NYSE listing, and that's reflected in the choices the Dow has made in bringing companies into the average.
2. The Dow's price-weighted methodology underweights Nasdaq-listed components
The relative lack of Nasdaq stocks in the Dow explains much of the difference in index performance. But related to that is the fact that the Dow's price-weighted methodology doesn't give the Nasdaq-listed stocks that do make the cut their fair influence compared to the Nasdaq Composite's calculation method, which is market-capitalization weighted.
The most obvious way this plays out is with Apple (NASDAQ: AAPL). With a market cap that has at times exceeded $3 trillion recently, Apple is by far the largest company listed on U.S. stock market exchanges. Yet because its price is relatively middle-of-the-road for a Dow stock at $170 to $175 per share, Apple gets only an average weighting of around 3.3% within the Dow. By contrast, for the Nasdaq-100 index, Apple's high market cap gives it a more than 12.5% weighting -- nearly four times the influence over the index's movements.
All told, the seven Nasdaq stocks in the Dow have only about a 20% weighting within the average. That's largely because three of the Dow's four lowest-priced stocks are Nasdaq-listed, combining for just a 2.9% weighting.
2 measures of the same stock market
Some argue that the Dow's idiosyncrasies make it a poor benchmark of stock market performance and that investors shouldn't pay any attention to it. Yet while it's true that the Dow marches to its own beat, it remains a popular way for non-investors to keep track of what's happening with the stock market.
Keeping track of both the Dow and the Nasdaq, therefore, can actually add some insight into what's happening in the market. As long as you understand why there can be differences in performance, the movements of the two indexes can point you toward trends that might help some stocks at the expense of others in the future.
