A Market of Stocks

The National Debt.
Government shutdowns.
War in the Middle East (or Ukraine.)
The Federal Reserve.
Politics in the United States (or abroad.)

We get asked about all of these, and many more.

Are we concerned?
What impact might they have in the short term?
In the long term?
Is the stock market going to fall?

When we get asked, we talk about what might happen. How the situation might evolve. How it might be viewed by the market? What the short or long-term impact might be.

But then we usually move on to say something along the lines of:

“Whatever event we are discussing might cause some volatility, but in the longer term, it probably won’t really matter. Because in the long term, what matters is companies and how much money they make. And so, while investors spend a lot of time talking about the stock market, what they should ultimately be focusing on is the market of stocks.”

3000+ companies

There are thousands of publicly traded companies in the United States alone. If you expand that to include international markets (which we think you should) that number swells to well north of 10,000.

Those companies are collated into a variety of different indexes, which market watchers, traders, and investors fixate on with varying degrees of scrutiny. Perhaps the most closely watched stock index is the S&P 500, which measures the performance of the 500 largest companies in the United States.

How the S&P 500 is Calculated

The S&P 500 is calculated using a “free-float market-capitalization-weighted” methodology. Because the index is weighted by market capitalization, movements in the stock price of a large company like Microsoft or Apple will have a much greater impact on the S&P 500 than movements in one of the smaller companies.

The calculation process is as follows:

Determine free-float shares: For each of the roughly 500 companies in the index, S&P Dow Jones Indices calculates the number of “free-float” shares. This is the total number of a company’s outstanding shares minus any closely held shares that do not trade publicly, such as those held by company executives or government agencies.
Calculate each company’s market cap: The number of free-float shares is multiplied by the company’s current stock price to determine its free-float market capitalization.
Sum total market cap: The free-float market capitalizations for all 500+ stocks in the index are added together to get the total market capitalization for the S&P 500.
Apply the divisor: The total market cap is then divided by a confidential proprietary number called the “divisor” to arrive at the final index value.

While the actual construction of the S&P 500 is perhaps irrelevant for most investors, consider for a moment what it means.

The S&P 500 tracks changes in the total market value of large U.S. companies
The market value of those companies changes over time
The biggest driver of market value is the current and future profits a company generates for its owners/shareholders

Investing doesn’t need to be complicated

Investing can be complicated. In fact, there are legions of people with PhDs in physics or math or whatnot that spend their lives analyzing every possible data point that might impact the movement of stock prices, sometimes in time frames of less than a second (seriously – trading firms have held arms wars and spent millions of dollars building the fastest possible fiber optic cables to route orders to an exchange a millisecond faster than their competitors. Think about that as you consider your ability to outcompete the professionals with your day trading.)

Those fractions of a second might matter when it comes to day trading, but for investors, the reality is: Who cares?

If we move out of the weeds a bit, topics like the Federal Reserve, the national debt, politics, etc. might matter over a period of days, or weeks, or months, or in some rare instances, even several years. For instance:

Tariffs and trade wars mattered for markets in the Spring of 2025; for about 6 weeks
Politics and national debts in Southern Europe mattered for some markets in 2011, for maybe 6 months before investors began reassessing their outlook
Subprime mortgages, a housing crisis, and the possible collapse of the entire global financial system mattered to markets in 2008 – but the markets began their recovery within about 18 months

So yes, these big, systemic issues can and do matter to the market – but their impact generally dissipates over time.

So, what really matters?

Now we get to the heart of the matter. What really drives the market value of companies, and in turn the level of stock markets around the world.

One word: profits.

That’s it. It’s that simple. Corporations exist to make money for their owners. For public companies those owners are shareholders. Higher profits are rewarded (over time) with a higher stock price, and a higher stock price leads to a higher market value. If that happens for enough companies, the total value of that group of companies increases, and the “stock market” increases with them. (One important caveat is that the price you pay for future profits also matters. Given enough time, companies can “outgrow” inflated stock prices. But as with any investment, the lower the price you pay, the more likely you are to achieve a reasonable return in a reasonable time frame.)

What’s the catch?

There is a catch though. Because the question then becomes: How do you know what companies are going to grow their profits?

Well, there are two ways to make sure you own the companies that are growing their profits. The first is to analyze individual companies in great detail, forecast their future earnings potential, and then buy the ‘best’ stocks before they go up. This is a logical approach, and a great idea in theory. Unfortunately, though, there is another catch.

It turns out that although this approach is logical, it is also really, really difficult to accomplish in practice, particularly for the span of decades (which is how long you’ll need to be successful at this if you want to accumulate enough money to retire over the course of a 40-year career and then distribute that money back to yourself during a 30-year retirement.) Unfortunately, even many of the world’s best professional money managers struggle to achieve this. In fact, as the chart below demonstrates, only 15% of active fund managers have outperformed their benchmark over the past 10, 15, or 20 years. Said differently, more than 85% of all fund managers fail to outperform their benchmark.

Percentage of Mutual Funds that Survived and Outperformed Benchmark¹

This failure has led to the rise of passive ETFs, where investors purchase a basket of stocks that recreate all or some of the available market.

A rising tide

Whether future market dislocations occur due to concerns about the national debt, policy mistakes by the Federal Reserve, political upheaval, or conflicts in the Middle East is an open question. But while financial professionals almost never “guarantee” anything, the reality is that there is an exceptionally high probability that some sort of bad events will occur in the coming months, years, or decades. And there is also a high likelihood that some of those events will lead to sharp market selloffs.

However, several centuries of capitalism have shown that companies consistently create products and services that enrich the lives of consumers while generating profits for said companies. Those centuries also demonstrate that companies are extremely adaptable, and that they can find ways to overcome a variety of external environments.

For instance, Coca-Cola was invented by an Atlanta pharmacist, and the first glass was sold on May 8, 1886. Today, Coke is sold in more than 200 countries and territories around the globe. Since its invention, just consider some of the economic and political environments Coke has had to overcome, including:

World War One
The Great Depression
World War Two
The Cuban Missile Crisis
Three Presidential shootings (William McKinley in 1901, JFK in 1963, Ronald Reagan in 1981)
The near collapse of the global financial system in 2008/2009
Covid and a lengthy period where many people literally could not leave their homes

Against this backdrop, experience shows that Coca-Cola has been adept at:

Making products people love like Original Coke, Diet Coke, and Coke Zero
Overcoming really dumb mistakes such as the “New Coke” experiment in 1985 when they changed their century-old recipe
Persevering thru wars, famines, upheavals, diseases, economic collapses, and assassinations, both in the United States and abroad
Creating a lot of money for its shareholders

As an example of this, Coke went public in 1919 at $40 per share. Between then and 2018, that same single share of stock plus reinvested dividends, would have increased in value to approximately $15.5 million!!!

The Bottom Line

Experience shows that profits ultimately flow back to shareholders, which in turn results in greater market value for the company generating those profits. And it is the increase in market value for those individual companies that ultimately drives stock indexes higher. And so, while there is almost always something worth worrying about in the external environment, the bottom line is that over time the market of stocks should continue to increase, provided you believe the following:

Companies are going to continue to produce goods and services that people want
People are going to pay for those goods and services
Profits from the sale of those goods and services will flow to shareholders

Next Steps:

Analyze the asset class mix in your portfolio to make sure it is aligned with your required rate of return and risk tolerance.
Review your investment holdings to see if there are any others that might enhance your portfolio.
Take a deeper dive into your overall financial situation using our free Financial Blueprint.