Chart of the day, equity and GDP edition

By Felix Salmon
March 22, 2012

The Epicurean Dealmaker has been watching global equity markets metastasize:

Over the past few decades, the public equity markets have evolved from a relatively staid and selective backwater, a playground for pension funds, insurance companies, and the idiot sons of wealthy men, into a gigantic global pool of capital, driven and supported by huge amounts of money from literally everybody… I will leave it to an enterprising PhD student to research the data, but I suspect the aggregate amount of equity market capitalization as a percentage of GDP has swelled tremendously over the past three decades. Equities have gone mainstream, and as they did, the size of equity markets ballooned.

To illustrate his point, TED talks of a fund manager who invests in no more than 100 stocks at a time. When he was managing $100 million in the 1980s, he could easily invest $1 million in a company; by the time his portfolio had grown to $10 billion in the 1990s, his average investment was north of $100 million per stock. That, in turn, makes it very hard for institutional investors to buy small-cap stocks, and helps to explain why small companies can’t IPO any more.

But that’s just anecdote; I wanted data. So I found an enterprising PhD student Ben Walsh, and asked him what’s happened to equity market capitalization as a percentage of GDP. And he, in turn, found Google:

There’s definitely an up-and-to-the-right trend here, but it’s very noisy, and we’re not talking orders of magnitude: global equity capitalization is probably about 50% higher now, relative to the size of the global economy, than it was in the 1980s. That’s an interesting trend, and a welcome one. But I don’t think it explains much about the IPO market. After all, the effective minimum size for IPOs has gone up much more than 50% since the 1980s.

I do think that maybe the distribution arms of the big sell-side equity underwriters have reached the point at which it just isn’t worth it any more for them to deal with any but the biggest accounts; I have a feeling that retail investors had much more access to IPOs in the 1980s and even during the dot-com bubble of the 1990s than they do now. But this is much more a function of the consolidation of the investment-banking industry than it is a function of the size of the equity markets as a whole.

Which opens up an intriguing possibility: is there some way in which the internet might be able to spawn a small, light broker-dealer which could underwrite IPOs aimed at retail, rather than institutional, investors? Think of it as fully SEC-compliant crowdfunding, without any need for a JOBS act. And if not, why not?

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11 comments so far

the chart actually looks pretty negative as its made lower lows and lower highs

Posted by dannettjm | Report as abusive

Surely there are fewer retail focussed IPOs now because the market appetite for stocks has yet to reawaken in the minds of ordinary folk? And in any case, there seems to be many more sources of Venture Capital and more Business Angels now than there was a decade or two ago.

Looking at the big picture though, what consequences do you see as a result of the growth of Market Cap as a percentage of GDP? Is it good that companies are getting bigger and bigger and hence more dominant as repositories of wealth that are controlled on an International scale by short term managers rather than by a more and more diffuse shareholder base?

Posted by FifthDecade | Report as abusive

Suppose this chart perfectly captured the output of all companies (so there was no variation over time in the proportion of listed vs. private companies). Then, changes in market cap/GDP would more or less consist of:

- Equity discount rates
- Perceptions of current GDP relative to “permanent” GDP (or long-run average GDP)

What you’d expect is that:
- When investors are fearful (discount rates are high), market cap to GDP is lower, and vice versa
- When GDP is temporarily depressed, market cap to GDP is higher, and vice versa

Those seem like reasonable explanations for what you see in the chart. I’m not sure why you think that this chart tells you much of anything about the IPO market.

Posted by Beer_numbers | Report as abusive

I thought that was approximately the idea of VC

Posted by dWj | Report as abusive

A significant factor in the decline of smaller equity underwriters is the long-term decline of equity trading commissions for both institutional and retail investors, which has occurred not only because of competitive factors but also due to regulatory changes beginning with deregulation of commissions in the ’70′s and continuing through decimalization of price quotes. It has saved investors a great deal of money, but it’s also shrunk the revenue pool that used to fund sell-side research. The predictable outcome is that smaller companies have a tough time attracting research coverage and hence don’t draw investor interest. The late ’90′s model where equity research was used to drum up investment banking business from companies was a flawed attempt to support research without relying on equity trading commissions, and of course the Spitzer research settlement ended that business model.

Grant Thornton has researched the topic and released a white paper proposing some intriguing solutions, though I’m not a fan of the proposed price-fixing (minimum commissions) –  /gtcom/menuitem.550794734a67d883a5f2ba4 0633841ca/?vgnextoid=e8eb2be99ea59210Vgn VCM1000003a8314acRCRD

Posted by realist50 | Report as abusive

I don’t think you’re looking at the chart properly, Felix. Market cap as a share of US GDP was 54.5% in 1988 and 119.5% in 2010. This ratio has more than doubled ($1.195 of equity capital per dollar of GDP vs 54.5 cents). By the same token, I think it may be an accurate guess to say that the minimum effective size of an IPO over the same period has more than doubled. Surely this explains a significant portion of the change. I presume one would have to adjust minimum IPO size for inflation over this period, too.

Posted by EpicureanDeal | Report as abusive

Your – or for that matter: any – enterprising PhD student should have recognized that the ‘ratio’ of MarketCap and GDP is in fact not a dimensionless number, but measured in years:

MarketCap = X [dollars], GDP = Y [dollars]/[year], so their ratio = X/Y [year].

For example, according to the chart, from 1998 to 2000, the NA ‘ratio’ wa 1.5 years.

It’s important to be aware of this before you start theorizing about trends.

Posted by Kamekon | Report as abusive

Note also that the “listed companies” whose market share in included Google’s calculation of market cap specifically excludes mutual funds, investment companies, and other collective vehicles. To the extent the *share* of the total equity market of said vehicles has increased over the past two decades–which seems reasonable to me–the chart above underreports the true ratio of equity dollars available for investment to gross economic activity.

Posted by EpicureanDeal | Report as abusive

(Of course that last point is mitigated by the fact that most collective investment vehicles invest heavily if not exclusively in listed companies, so there would be a great deal of double counting.) / end

Posted by EpicureanDeal | Report as abusive

I should have referred to Beer_numbers’ comment @11:40am. which I only read properly after I had posted mine and which ties in nicely with what I said, in particular where B_n points to discount rates.

Posted by Kamekon | Report as abusive

@EpicureanDeal, “the true ratio of equity dollars available for investment to gross economic activity”:

If that’s what you’re interested in, then the above chart seems largely irrelevant. MarketCap (a stock variable, see my comment re dimensions) reflects the value of past investments. It may vary without any change to investment or ‘equity dollar availability’.

In relation to investment, equity funding should be conceived as a flow variable, like investment. In macroeconomic terms:

Y = C + I or S = I and you’re looking for the equity part of S – or, more exactly, for the IPO part of the equity part.

Posted by Kamekon | Report as abusive
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