12 May 2022

What Drove Up Stock Prices - And Why Stock Prices Will Rise Again

Between 1980 and 2008, the number of Americans dependent on investments like 401(k)s for retirement tripled. (And I suspect it has continued to rise.)
Compared to its peak about 1998, the number of publicly traded companies has fallen to about a third.
Triple the demand. A third of the supply. I don't know how that does anything other than make prices seem high.


The number of publicly listed companies in the US has steadily declined since its peak in 1996. That has a lot to do with market volatility and crazy stock prices.

In the last few decades, the portion of Americans with pensions has halved and the portion dependent on the stock market for retirement has tripled.[1]

During that same time, the number of publicly listed companies - companies whose stock you can buy and make a part of your retirement account - has fallen to about one-third of its peak. [2]

And here we have one important problem with pricing stocks.

If we just look at supply and demand, the supply of companies whose stock you can buy has fallen to a third of its peak and if we just look at demand for stocks, the portion of Americans dependent on stocks for retirement has tripled. If the supply is a third and the demand has tripled, the price has no where to go but up. From this angle, crazy high stock prices are very reasonable.

Meanwhile, we have traditional measures of stock value. Traditional as in it generates profits. If you pay $100 for a share of stock, ideally that would represent - say - $5 a year in profits. The price of $100 relative to the profits of $5 works out to a Price to Earnings ratio (PE) of 100/5 = 20. What seems reasonable from a perspective of PE is something in the range of 15 to 35. (If you are expecting big growths in profits and interest rates are low - which means you discount those future profits less - PE ratios considerably higher than 15 to 35 are justified. That is to say, a growth stock could reasonably have a very high PE.) Even though Tesla has fallen by about 40% year to date, its PE is still 100. That's really high and a lot of stocks in the last year have had either really high PE ratios - or given they are not yet profitable - no PE ratio.

If we only look at PE, the stock market has been wildly overpriced.

But if you look at the demand for stocks v the supply of stocks (again, the number of publicly traded companies), the stock market has arguably been reasonably priced. People need a way to build wealth for retirement. There are not many companies being traded. The result is that the price of companies - the value of their stock - will go up. (I suspect that this fundamental demand is going to drive stock prices back up.)

There is more going on with asset prices than this but I don't think enough is said about this tension. Stock prices have been quite reasonable given growing demand for a shrinking number of stocks even though from the perspective of PE, stock prices have been silly.

What is the solution? Well, you know me and my mantra about entrepreneurship now being the limit to progress. We need more initiatives - public and private - to make more people more entrepreneurial. One simple reason? We have more capital than good investments right now. The two limits to creating more investments are public policies (for initiatives like reducing child poverty and infrastructure investments) and private initiatives to start more companies that can go public.

One way to meet the demand for publicly listed companies without making stock prices higher than PE would seem justified is to create more companies. That's going to require more entrepreneurs. More effective entrepreneurs can meet the demand for good investments without driving up the price of assets to seemingly unsustainable levels.

[1] https://www.ssa.gov/policy/docs/ssb/v69n3/v69n3p1.html
[2] https://fred.stlouisfed.org/series/DDOM01USA644NWDB

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