The Big Bang: Stock Market Capitalization in the Long Run
CEPR Discussion Paper No. DP14468
81 Pages Posted: 30 Aug 2018 Last revised: 21 Aug 2020
Date Written: August 19, 2020
Stock market size and economic activity were closely linked between 1870 and 1990 but diverged markedly afterwards. New data show that the market cap to GDP ratio across 17 advanced economies was constant at around one-third for over a century, tripled in the 1990s and remained at this high level thereafter. We trace the drivers of this long-run disconnect to two underlying factors: a profit shift towards listed firms away from other sectors of the economy, and historically low discount rates. Equity issuance and new listings, on the contrary, make next to no contribution to this trend. Turning to short-run market fluctuations, we show that cyclically high capitalization forecasts low equity returns, low dividend growth and a high risk of a stock market crash. This suggests that the currently high valuations and capitalization are a sign of high, rather than low risk in equity markets.
Keywords: stock market capitalization, wealth-to-income ratios, corporate profits, equity valuations, long-run trends
JEL Classification: E44, G10, N20, O16
Suggested Citation: Suggested Citation