Averaging stock market capitalization to GDP ratios from seventeen developed economies over the past 150 years reveals the world has never witnessed an equity bubble of the current magnitude.
The weighted average of seventeen stock market cap to GDP ratios reached 162% at the end of the third quarter of 2021, which is the highest ever since 1870. It’s unlikely it has been higher previous to 1870, because economies were not as intertwined then. Most likely, equity bubbles were more local. In addition, before 1870 countries were commonly on a metallic standard that prevented long periods of excessive speculation.
During the dot com bubble in 2000 the weighted average of the developed world market cap to GDP ratio reached 123%, and during the credit bubble in 2008 it hit 116%. Before the 1980s it only once transcended 75%. Clearly, something drastically changed in financial markets around the 1980s.
Perhaps you wonder why I think stock markets are in a bubble, as opposed to fairly valued in a new economic paradigm. My answer is simple: if I look at stock market cap to GDP levels in the chart above, and every peak in the past 150 years was a bubble, why wouldn’t the current peak, higher than every previous peak, be a bubble?
In trying to build a long-term gold valuation model and collecting macro data from as far back as possible, I stumbled upon an academic paper from Dmitry Kuvshinov and Kaspar Zimmerman: The big bang: Stock market capitalization in the long run. Kuvshinov and Zimmerman (K&Z) did a high-level investigation to gather stock market data of seventeen developed countries* from 1870 through 2016. After these gentlemen shared their data with me, I searched for the market cap numbers from 2017 until Q3 2021 that matched the K&Z methodology (selecting only domestic ordinary shares). All the data combined is visible in the above chart.
The conclusion of the K&Z paper is that until the 1980s stock market caps in developed economies grew roughly in line with GDP. Hence, the weighted average market cap to GDP ratio hovered around 50% for 110 years. Since the 1980s, market cap growth accelerated much faster than GDP, caused by increases in stock prices, not issuance growth. According to K&Z the key reason has been a profit shift from other parts of the economy towards listed firms. And higher profit margins have mostly been aided by lower interest expenses.
From researching the exact cause why stock markets exploded in the 1980s (I think only interest expenses is not the full story) I ended up in a “rabbit hole” that I have yet to come out off. When I have finished my analysis, I will certainly publish it.
For those who missed one of my previous articles, in the United States stock market cap to GDP ratio peaks over the past 120 years have always been followed by a higher gold price. After the peak in 1929, the 1970s, 2000 and 2008 the dollar devalued against gold.
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I would like to thank Dmitry Kuvshinov and Kaspar Zimmerman for sharing their data, and Charlie Morris, Luke McInnes and many others that helped me obtain the most recent figures of domestic stock market caps.
* Australia, Belgium, Canada, Switzerland, Germany, Denmark, Spain, Finland, France, the U.K., Italy, Japan, Netherlands, Norway, Portugal, Sweden, and the U.S.
Looking at absolute valuations is a problematic affair: the real interest rate has declined for 500 years (https://www.bankofengland.co.uk/-/media/boe/files/working-paper/2020/eight-centuries-of-global-real-interest-rates-r-g-and-the-suprasecular-decline-1311-2018). When real yields decline stock valuations should go up. So looking at them vs gdp without adjust for interest rates does not work well.
Look at it this way: people have for hundreds of years accumulated financial wealth. This has particularly been the case since the 80s as the tax regime fundamentally changed in favor of companies and wealthy people. The wealthy don't hold much wealth in cash (say around 10% of their financial wealth) - they hold stocks and bonds instead.
As they accumulate more and more money due to income concentration they need to buy more assets. If the economy can't provide enough investment opportunity asset valuations will increase - which is another way of saying yields will decline.
You can look at relative valuations or at valuations relative to real interest rates. But spending too much time on absolute valuations just makes you miss out and generally feel miserable.