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Measuring Stock Market Growth: What Does the Growth Mean?

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The bears remain in the background as we continue to experience the second-longest running bull market in history. The Dow Jones Industrial Average passed the 23,000 mark for the first time on Oct. 17 after reaching the 22,000 mark only in August. The Dow has passed through four major milestones in 2017 alone, which is a sign that the bulls remain fully in charge.

The S&P 500 has also been on a run over the past year. In fact, this diverse index has gone more than 242 trading days without experiencing a decline of at least 3 percent, which is a new record. On Oct. 27, both the S&P 500 and Nasdaq closed out at all-time highs after stronger-than-expected earnings from major tech players Alphabet Inc. (Nasdaq: GOOGL), Amazon.com Inc. (Nasdaq: AMZN), Intel Corp. (Nasdaq: INTL) and Microsoft Corp. (Nasdaq: MSFT).

As the gains in the market continue towards the end of 2017 and into the coming year, here is how we measure those numbers and what that growth means.

Why the Stock Market is Important

When investors buy stocks in a company that has an initial public offering (IPO), it allows that company to raise money for operations and growth. Owning stocks also permits institutions and individual investors to build wealth through capital gains and dividends. Of course, if the stocks lose value, investors can also have a capital loss should they decide to sell their shares.

The U.S. stock market represents the financial trading hub of the wealthiest nation in the world. The current GDP of the U.S. economy is $19.42 trillion which represents 25 percent of the gross world product. The U.S. has a market capitalization of $27.3 trillion, which is nearly four times as high as its closest rival China at $7.3 trillion.

How We Measure Stock Market Performance

Before we can make sense of stock market growth, we need to be able to track growth in the market. The most common way to do this is by using stock market indices. There are several main market indices that track the daily movements in the marketplace. Among them are:

  • The Dow. The Dow Jones Industrial Average (DJIA) is one of the most well-known and commonly used stock market indices. The DJIA includes just 30 stocks that are considered the most influential U.S. companies.
  • The S&P 500. The S&P 500 is a much broader index of the 500 most widely traded stocks in the U.S. The index is supposed to give a good indicator of the movement of the U.S. stock market as a whole as its stocks are weighted according to their market caps.
  • The Nasdaq Composite. This is an index of all stocks traded on the Nasdaq exchange that is weighted according to market cap. Some Nasdaq companies are not based in the U.S., and the Nasdaq is known to be heavy in tech stocks.
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What Stock Market Growth Measures

Indices can tell us which way the stock market is moving at any given time, but what that growth, or lack thereof, means is another story. Essentially, stock market growth is a measurement of two things - corporate earnings and investor confidence. Interestingly, both of these are interrelated factors.

When the stock market grows, those gains are meant to reflect the underlying fundamentals of the traded companies. For example, when Amazon and Alphabet reported positive earnings on Oct. 27, their share prices rose 11 percent and 7 percent in one day respectively.

How much the stock market moves and how quickly can give us an idea of investor confidence, also sometimes referred to as investor sentiment. While we all seem to agree that the market is "bullish" right now, how do we come up with this conclusion? In short, there are various indices that provide this data. CNNMoney's Fear and Greed Index is one and the CBOE Market Volatility Index, or VIX, is another.

These various indexes give an indicator of whether or not investors feel confident putting their money into the market or have a sense of uncertainty about the future. As more investors put their money into the market, particularly into IPOs, we'll see continued growth which will fuel even stronger investor sentiment. Of course, the opposite is true as well where negative investor sentiment keeps capital out of the markets and prevents growth.

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When Stock Market Growth Measurements Fail

In some cases, the measurements of stock market growth aren't as accurate as we would like, which can pose a problem for this system. When a stock's value doesn't equate to the underlying fundamentals, it is considered overvalued. When the market as a whole is overvalued, we find ourselves in a bubble, which is dangerous territory.

There is a market valuation measurement called the Shiller PE ratio that calculates the market's overall value against the earnings of its companies. Right now, that ratio is at its third-highest value in history, which is an indicator that our market is overvalued. The only two times that this ratio was higher was before the 1929 stock market crash and just prior to the dot-com bubble bursting.

There are some fears that a downturn in the market is on the horizon, but those could be unfounded. The last stock market crashes were accompanied by corporate earnings contractions, which is something that we have yet to see. The good news is that banks can limit their exposure by partnering with a service-oriented asset management team.