Global stock markets, explained: what an index actually tracks

On any given business day, broadcasters report whether the Dow Jones closed up or down, whether the ASX 200 had a good session, or whether Asian markets followed Wall Street. These numbers are treated as vital signs of economic health. They are useful signals, but they measure something specific and limited, and understanding exactly what they track helps make sense of why markets can rise while workers' wages stagnate, or fall while the underlying economy keeps growing.

What an index actually is

A stock market index is a calculated number that represents the aggregate value of a selected group of company shares. The selection rules vary: some indices include all listed companies above a minimum size, others focus on a fixed number of the largest companies, and others weight by sector or other criteria. The S and P 500, for example, tracks five hundred large US-listed companies. The ASX 200 tracks two hundred of Australia's largest listed companies by market capitalisation. Because the biggest companies have the most influence on the index number, a handful of very large companies can move the whole index substantially while hundreds of smaller ones barely register.

What markets price in, and when they get it wrong

In theory, share prices reflect investors' collective estimates of the future earnings of a company, discounted to present value. In practice, prices also reflect sentiment, momentum, fear, and speculation. Markets are forward-looking, which means they often move before economic data confirms a trend, and they can move sharply on the basis of expectations that later prove wrong. A market index can rise because investors expect interest rates to fall, not because companies are currently profitable. It can fall because of uncertainty about future policy even when current economic conditions are strong. This mismatch between market performance and immediate economic experience is the source of considerable public confusion.

The global interconnections

Major stock markets are linked in ways that make a sharp move in one market transmit quickly to others. This happens because the same large institutional investors operate across markets, because currency and interest rate movements affect all markets simultaneously, and because sentiment about global growth shifts together. The opening of the US market each day tends to influence Asian and European markets in subsequent sessions, and vice versa. This does not mean all markets move identically, countries with different economic structures, interest rate cycles, and sector compositions will diverge over time, but short-term contagion is a consistent feature.

What it means for Australia

A large proportion of Australian superannuation savings is invested in domestic and international equities. When global stock markets fall significantly, the balance of superannuation accounts falls with them, at least on paper. Over long periods, equity markets have tended to deliver returns above inflation, which is why superannuation systems invest heavily in them, but this requires tolerating short-term volatility. The ASX is heavily concentrated in financial sector stocks, principally the major banks, and in resources companies. This means the Australian index is more sensitive to Chinese demand for commodities and to domestic interest rate movements than to technology sector performance, making it behave differently from US markets even when they are correlated.

The bottom line

A market index is a measure of the collective value of listed companies, not a direct report card on the economy. It is a useful signal, but it is forward-looking, sentiment-influenced, and dominated by the largest players, which means it can diverge from everyday economic experience in ways that are normal, not aberrant.

This article was compiled by AI and screened before publishing. See our editorial standards.