Speculations about long term stock market trend have become an ordinary informational noise over past 5-6 years. Some observers have been strongly advocating for upcoming recession, pointing at risks of non-stop “all time high” indexes rally. Others are trying to stretch the economic cycles concept, that predicts that economy must cool down every decade. Yet market cap boom goes on ignoring all obvious political and financial uncertainties.
In order to better understand the nature of continuous index rise over past decade, it would make sense to look at the long run trend. For that purpose, let’s use inflation adjusted data that allows to see the real market growth trajectory over long period of time.
It is noteworthy that prosperous 50s and 60s (baby boom gen) produced an incredible surge in real value market growth: capitalization spiked 3.5 times over a decade.
The oil crises of 70s threw the market back to the level where it had been stagnating in the whole first half of the XX century, basically back to 1916! And it took almost three decades - until early 90s to re-gain the inflation adjusted market value of the mid 60s.
The entire decade of 90s was marked with an unprecedented rally of the stock market that increased the market cap by 2.7 times - again, measured in inflation adjusted dollars, that shows the real growth of indexes.
It took economy just 12 years to overcome the consequences of two bubbles: dot com crush (2000) and Great Recession of 2008. We are currently back to speed, inflation adjusted all time high of 2000 (pre-dot com crush) had been overcome in 2012 and we are hitting new highs.
Now, it is important to take a quick moment and recap on what the market cap actually means for the economy. Some would say, it’s all speculation and that windfall profits have been pocketed by the small group of asset managers.
That is obviously not true! All American retirement savings are invested in stocks. Therefore 100 million individual investors became 2.7 times richer in the 90s. Measured in inflation adjusted dollars!
So basically, market cap is an equivalent of the generational wealth for the enormous number of individual families. Well, following the stock market trend, the entire economy is picking up, all assets are gaining in value: real estate, infrastructure, and even intangible assets. Simply put, the economy is becoming more capitalized.
There are various counteracting and even negative consequences of the accelerated market growth. For example, it is the main contributor to the structural dis-balances like income disparity and alike. The way economy is re-gaining the balance could be a subject of the different research. But now let’s focus on the market cap trend.
What caused the unprecedented momentum in the 90s? And what is causing it now? How would wealth tripled in value over decade in 90s and doubled again since 2012 when it surpassed the previous all time high reached in 2000?
Partly, it would make sense to look at the domestic economy as the fundamental source of growth. 90s and 2000s have been the time of the large scale technological innovations; it’s been the time of creation of the entire Internet economy. However, measured in terms of GDP, the economy has not grown 5 times (inflation adjusted) since early 90s till now. Therefore the true source of explosive growth of wealth over past less than three decades does not lie completely in the domestic economy. Instead, it is part of the broader global process that leads to capitalization boost.
Since late 80s the world economy has been actively integrating so called emerging markets. The term “emerging markets” used to be popular back in 90s and since then it has partly lost its traction due to intense economical globalization of last decades. Former socialist block countries: Eastern Europe, Russia and of course China have become the intrinsic part of the world economy. These national markets have obtained their own capitalization (measured in real market value) almost from scratch.
Back in 1990 the total world stock market capitalization used to be $9 trillion with US share of over 40% (nominal dollars).
Last year the world’s stock market cap surpassed $70 trillion with the US share of about 44% (nominal dollars).
So how does the global capitalization trend affect capitalization of the US economy?
To answer that question, it would make sense to illustrate the problem on a simple real life example. Let’s say there is a neighborhood with half of the households wealthy and the rest - low income (let’s call them “under-capitalized” households). There is certain level of infrastructure and local businesses servicing the neighborhood.
Now the “under-capitalized” part of the neighborhood starts getting value and wealth. Over a period of time, under-capitalized households become richer, renovate their properties, upgrade infrastructure, extend driveways, buy more vehicles, as well build better schools, and start attracting more servicing businesses: banks, stores, restaurants etc. They start investing more money in living and improvements.
Increase of wealth in the under-capitalized households will drive the value of the entire neighborhood up. The wealthy part of the neighborhood will gain in value just because of the flourishing local economy, even if their income and expenses (the wealthy households) do not go up.
Similar “synergistic” effect is happening to the entire world economy with local markets gaining additional capitalization and leveraging capitalization of the developed markets.
Within reasonable market cap to GDP ratio range (varying historically from 0.6 to current 1.5), further market cap growth potential lies in closing the gap between nominal dollar GDP and PPP GDP (GDP measured in terms of purchasing power parity). Currently, global nominal GDP is still lagging behind the PPP GDP by 40%. It means that a significant portion of the world output remains undervalued and therefore the underlying assets - under-capitalized.
US economy will most probably continue to hold its share of the world’s market cap, taken its pivotal role on the global capital markets. As never before, American market is exposed and driven by the global capitalization trend.
There is a great chance that the index rally will continue in 2020. The world is getting richer and assets will continue to gain value worldwide. American economy should be ready for that challenge. With the investment assets becoming more expensive, structural dis-balances will also accumulate.
Comments