Indices / Sectors :: Trading ASX Shares with Stuart McPhee

Indices / Sectors

Indices represent the value of a group of stocks. The most commonly used indices represent the value of the largest companies on an exchange and all exchanges will have a primary index which is widely available.

The value of an index is irrelevant except in relationship to itself. For example, the most widely quoted index is the Dow Jones Industrial Average (DJIA) which tracks the performance of 30 large companies listed on the NYSE. If the value of DJIA is 12000, this number doesn’t represent anything – it is just a running total. Therefore, what we can do is monitor the changes to the value and therefore determine how the market is generally performing over time.

Some other major indices across the world include the S&P 500 from the NYSE, the NASDAQ, the FTSE 100 Index (UK); the Hang Seng Index (Hong Kong), the Nikkei (Japan), the Straits Times Index (SGX), the Kuala Lumpur Composite Index (Malaysia), the S&P/TSX Composite Index (Canada) and finally the All Ordinaries Index and S&P 200 in Australia.

A limitation of many indices is that they are weighted according to market capitalisation. This means that the larger a company is, the more influence it has on the calculation of the value of the index that it is a part of.

This problem can be accentuated within various industrial sectors (which are represented by their index) where it is common for one or two large companies to overshadow the remaining companies within the sector. This can sometimes provide a distorted view of the performance of an individual sector.

Global Industry Classification Standard (GICS)

GICS is a joint Standard & Poor’s/Morgan Stanley Capital International product, aimed at standardising definitions of industry sectors across the world’s markets. Markets are now adopting this approach to categorising companies which allows investors to compare industries in other countries with similar industries in your own country.

The GICS details 10 sectors as follows:

Consumer discretionary
Consumer staples
Energy
Financials
Health care
Industrials
Information technology
Materials
Telecommunications
Utilities

Some stock changes may slightly alter the list above in order to accommodate their own individual market requirements. For example, the ASX has a large number of listed property trusts and therefore they have an additional sector just for property trusts.

A traditional investment approach suggests that you purchase shares in the strongest companies in the strongest industry sectors. The strength of this approach is that the sharemarket goes through cycles in which certain industry sectors perform well under certain economic conditions while others do not do so well.

If a sector is performing poorly, it is quite common for most, if not all, companies in that sector to perform poorly also. This is exactly the same for sectors that are performing well. An index is calculated and published for each GICS sector, making it easy to track the performance of individual sectors by analysing their corresponding indices.