Why the S&P 500 outpacing rival Dow as stocks rally

From MarketWatch:

The S&P 500 Index and the Dow Jones Industrial Average are commonly used to measure the performance of U.S. stocks, but the disparity in the benchmarks' returns this year during the powerful rally highlights their different approaches to tracking the market.

So far in 2009 through Wednesday's close, the S&P 500 had posted a year-to-date gain of 17.1%, handily outpacing the Dow's 10.8% rise.

"While the Dow Jones Industrial Average and the S&P 500 share the spotlight as the two most-watched measures of the U.S. equity markets, the behavior of these indexes does vary considerably based on market conditions," said Nicholas Colas, chief market strategist at ConvergEx.

"During up-trending markets, the broader based S&P 500 has the edge. During down markets, however, the Dow outperforms," Colas wrote in a report Thursday. "The recent weakness in the U.S. dollar should benefit the more multinational Dow, especially if the greenback's weakness spurs a long-awaited market correction."

The performance gap between the S&P 500 and the Dow is due to several key methodology differences, even though investors see both indexes used in media reports recapping the market's daily moves.

First, the 30 stock components in the venerable Dow are weighted by share price. The S&P 500, on the other hand, uses a market-capitalization-weighting strategy.

The broader S&P 500 holds a greater number of stocks and so digs deeper into markets by holding more smaller-cap companies. Read earlier story profiling the indexes.

Blue-chip battle

Both indexes have a subjective element because the stocks are selected by people rather than by objective rules. The stocks in the Dow are chosen by the editors of The Wall Street Journal, while an index committee maintains the S&P 500....MORE