Perception and psychology have a lot to do with interpreting stock market performance, but there are also definitive components of the economy that drive market health. Broad market indexes that trade based on the investment performance of individual stocks, such as the S&P 500 index in the U.S., offer an indication of stock market performance. Also, investor sentiment can be based on a number of factors including but not limited to corporate profitability.
A major stock market index may be comprised of industry-leading stocks in the markets. Trading in this index is one representation of stock market performance. If trading in this major index is positive, it means that some of the largest companies that trade shares are increasing in value. When the index is losing value, it is an indication that one or more stocks in the market index are declining. It is possible for one stock in an index to pull the entire index lower or push it higher.
Stock market performance can also be gauged by an industry index. For instance, a market index can be made up entirely of stocks that trade in the energy industry. The indexes might drill down further to include only oil services stocks, such as drillers, or perhaps renewable or alternative energy companies. While trading in this index may not be a measure of broad stock market performance, it gives a sense of the way investors are perceiving and treating an industry at a given time.
Just because a stock market may be going through a downturn, this does not necessarily mean that corporate profitability is lagging. On the other hand, a stock market surge could be driven more by investor psychology than anything else. There are frequently outside events that can influence stock market performance, such as government elections, economic indicators, or even seasons of the year. For instance, a Santa Clause rally is something that traditionally occurs during the Christmas holiday season when stocks tend to rise in celebration of the holiday or for other reasons, such as anticipated tax benefits or year-end financial bonuses.
When the stock market goes through prolonged periods of gains, this is an indication of a bull market, where investors and traders alike can make money hand over fist. A pullback in stock market performance over many months is representative of a bear market, where investors and traders are attempting to take profits by selling shares in stocks and investing elsewhere, such as the bond market. The financial markets tend to be cyclical and go through both bull market and bear market cycles.