Addi, I'll give it a shot. NASDAQ is a market-value weighted index. So
assuming that there are only two stocks in the index:
On 1/1/196X - the date the index started:
Stock A valued at $100 (outstanding shares 10) - large cap
Stock B valued at $100 (outstanding shares 01) - small cap
The capitalizations are:
Stock A - $1,000
Stock B - $ 100
Total - $1,100
The value of the index is some number representing this value
so for simplicity assume that on 1/1/1980 this NASDAQ composite's
value is 100 (your starting value can be anything you want).
Now fast forward to 1/1/1998:
Stock A valued at 1 (still shares outstanding = 10) - large cap fall
Stock B valued at 100 (outstanding shares = 1) - small caps flat
Total cap - 1*10 + 100*1 = $110
Now the value of the NASDAQ index is 10. (100/$1,100 * $110 = 10)
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So the large cap went down 99%, the small cap went down 0%, and the
index went down 90%.
Conversely you can see that if the small cap declined 99% and the
large cap was flat, the index would have fallen only 9%.
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Hence the effect of the large caps is magnified. If CSCO,INTC,MSFT,
ORCL,AMAT,AMGN and a few others are so far ahead in terms of market
cap relative to the other stocks in the index basically what you've
got is a tech index. It does not matter if you have 500 financial
services firms, 300 water purifier firms,etc as long as their total
cap relative to the big boys is minute. You can therefore exclude
all the little caps (upto some degree of approximation) and still
get a value of the index that's pretty accurate by including only
the top tier stocks - which happen to be all tech stocks. To give
you an idea of the dominance of the large caps check out the NASDAQ
100 where MSFT is responsible for a fifth of the value of
that index, INTC is responsible for 15% of the value of
that index! So two stocks represent a third of that index!!!
With the NASDAQ composite the %ge will be lower because all the
smaller caps will be included but still it shows the dominance
of these 2 companies. The bigger they get the more important their
value in the index.
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re: why the index is not lower. My guess is that the stocks peaked
at different times therefore the index would have smoothed the effect
of the prectipitous falls. Also MSFT has not fallen and CSCO has not
fallen. They are responsible for probably somewhere around 10-20% of
the composite (total guesswork). |
