We hear in the news every day about the rise or fall of the stock markets, by so many “points” or by this percentage. But what is it that is being reported and what does it mean? There are many different numbers being reported, the most common being the S&P/TSX Composite Index, Dow Jones Industrial Average, S& P 500 Index, NASDAQ Index. These are indexes comprised of the stocks of the largest companies listed on that particular stock exchange.

There are many stock market indexes for each nation’s largest stock exchange, such as the British FTSE 100, the Japanese Nikkei 225 and the Hong Kong Hang Seng to name a few. There are specialized indexes to benchmark particular types of industries like small-cap stocks or bio-tech stocks etc. To try to make more sense out of these indexes, we will concentrate and refer to the Canadian market and the S&P/TSX Composite Index.

The Toronto Stock Exchange (TSX) is based in Toronto. It is the largest stock exchange in Canada and the third largest in North America. In 1999 through realignment the Toronto exchange became the sole exchange for trading of senior securities representing a broad range of companies from Canada, the United States and other countries. The TSX includes all five major banks in Canada, including the CIBC, Bank of Montreal, Bank of Nova Scotia, Royal Bank of Canada and the Toronto-Dominion Bank. The exchange is also the primary listing for the energy and mining sector and more of these companies are listed than on any other exchange in the world.

The S&P/TSX Composite Index therefore represents the largest companies on the Toronto Stock exchange as measured by their market capitalization (value of their shares). The index represents approximately 71% of the market capitalization of the Canadian-based companies listed on the TSX and as previously noted is heavily weighted in the financial services and the mining and energy sectors.

One might then think that the index is calculated by simply adding up the share prices of the companies that comprise the index at the end of each day of trading. In most instances this is not the case as the index is weighted so that the prices of the larger companies are given more “weighting” than are the prices of smaller companies included in the index. This means that the shift of one company can significantly influence the index and that if a relatively small number of the largest companies (i.e. the bank stocks) decline on a given day, the TSX Index can be down even though most companies on the exchange show an increase.

This is just an introduction to next week’s column on market volatility so that we can understand where these numbers are derived from and how we can make this work for us.

July 21, 2008