The most popular understanding of the U.S. stock market is the S&P 500 Index (SP5) of leading U.S. companies. Introduced in 1957, it is the most widely cited index, and more money is managed to it, by far, than any other benchmark. As such, SP5 has become a proxy for the health of U.S. investors, corporate America, and the overall economy. While SP5’s growth and prominence over the past half-century is well known, few market observers stop to ask basic questions: Why was it created? What need did it fill? What has happened since? And most importantly, is it still fit for purpose? That last question is the focus of this essay.
Nearly seventy years after its creation, SP5 may be fit for purpose, but it is clearly no longer the narrow one of the 1950s. While SP5 was initially a tool for measurement and understanding, it has over time become a central actor in shaping investor behavior. The widespread use of SP5-based products now actively influences the market SP5 was intended merely to observe. Though not a true observer paradox in the quantum physics sense, the feedback loop between measurement and subject has become pervasive. The consequences have been many, but perhaps the most significant one has been the widening gap between investment in the stock market and actual ownership of businesses through the stock market. This phenomenon, in turn, is a distinguishing characteristic of “financialization,” a criticism leveled against Wall Street in recent decades for focusing on generating financial returns regardless of, or even in opposition to, outcomes in the real economy.
The personification of an impersonal system is not unusual in a complex society. In the case of SP5, I would suggest that Dr. Frankenstein’s creature is the right character. Mary Shelley’s story, Frankenstein from 1818, is a tale of how scientific progress can diverge wildly from the plan. SP5 tracks that narrative all too well.
Bringing Order to Chaos
It did not start out this way. When SP5 was launched, it was a vast improvement over the numerous industry and early market averages that had appeared in the late nineteenth and early twentieth centuries. Those primitive measures struggled with stock splits, stock dividends, and dividend payments. Over time, they tended to become distorted. As one critic noted in 1957 at the launch of SP5, even if all the constituent elements of those older indices went to zero, the index could still have a positive value. More importantly, these earlier market measures, often associated with media platforms, were mostly indices of price, not size. They did not capture what we now call market capitalization but what was referred to at the time as market value. While indices of value existed, due to calculation limitations, they were neither broad nor timely. The most advanced Standard & Poor’s products prior to 1957 were a value-weighted index of 233 stocks calculated weekly, and one representing ninety companies calculated daily after the market close. Both had been launched in the 1920s.