We are entering the biggest global equity bubble ever

Author: Jan Nieuwenhuijs

Data on the total stock market capitalization to gross domestic product (GDP) of seventeen developed economies over the past 150 years shows that the world has never moved into a bubble of its current size.

The weighted average of seventeen "market capitalization to GDP ratios" reached a whopping 162% at the end of the third quarter of 2021, which is the highest level since 1870. I have not been able to obtain any data from before 1870, but it is unlikely that this average was ever higher before 1870, because economies were not as intertwined in the past as they are today. Most likely, bubbles used to be more of a local phenomenon. Moreover, before 1870, countries usually had a monetary system based on gold or silver that prevented long periods of excessive speculation.

Source: Dmitry Kuvshinov and Kaspar Zimmermann (2021). "The Big Bang: Stock Market Capitalization in the Long."    

During the dot-com bubble in 2000, the weighted average of the developed world's market capitalisation to GDP reached a level of 123%, while during the credit bubble in 2008 that level peaked at 116%. Before the 1980s, it exceeded 75% only once. Apparently, something drastically changed in financial markets around the 1980s.

You may be wondering why I suppose stock markets are currently in a bubble, as opposed to being healthily valued in new economic paradigms. My answer is simple: if I look at the weighted average of market capitalization to GDP ratios in the chart above and every peak in the last 150 years turned out to be a bubble, why shouldn't the current peak, which is higher than any previous peak, be a bubble?

I was actually working on creating a long-term gold valuation model, collecting as much macro data from history as possible, when I stumbled upon an academic paper by Dmitry Kuvshinov and Kaspar Zimmerman: The big bang: Stock market capitalization in the long run. Kuvshinov and Zimmerman (K&Z) conducted an in-depth study to compile stock market data from 1870 to 2016 from seventeen developed countries*. After they were kind enough to share their data with me, I started looking for the figures from 2017 to the third quarter of 2021 that matched the K&Z methodology (domestic equities only). All data together is shown in the graph above.

K&Z's conclusion is that market capitalizations in advanced economies grew roughly in line with GDP until the 1980s. As a result, the weighted average market capitalisation to GDP ratio has fluctuated around 50% for 110 years. Since the 1980s, the growth of market capitalizations has accelerated faster than GDP, caused by increases in share prices, and not by the growth of issuances. According to K&Z, the main reason was a shift in profits from other parts of the economy to publicly traded companies. And higher profit margins were mainly supported by a decrease in interest expenses.

By researching the exact cause of the stock markets exploded in the 1980s (it seems unlikely to me that it could have been just lower interest charges), I ran into a very complicated story that I haven't figured out yet. When I'm done with my analysis, I'll be sure to publish it.

For those of you who want to be one of my Missed Previous Articles: peaks in market capitalization relative to GDP over the past 120 years in the United States have always been followed by a higher gold price. After the stock market crash in 1929, the 1970s, 2000s and 2008, the value of the dollar fell against gold.

Source: Dmitry Kuvshinov and Kaspar Zimmermann (2021). "The Big Bang: Stock Market Capitalization in the Long."    

I would like to thank Dmitry Kuvshinov and Kaspar Zimmerman for sharing their data, and Charlie Morris, Luke McInnes and many others who helped me obtain the most recent figures of domestic market capitalizations.

*The countries from which data was collected are Australia, Belgium, Canada, Switzerland, Germany, Denmark, Spain, Finland, France, the United Kingdom, Italy, Japan, the Netherlands, Norway, Portugal, Sweden and the United States. 

This article originally appeared on The Gold Observer