WHAT DOES REALLY DRIVE THE STOCK
MARKET?
Accounting for the last 50 years.
Michele Boldrin
Adrian Peralta-Alva
April 21, 2003
1
Long-run behavior of the stock of capital in relation to output
We ask:
is it consistent with ANY model of capital accumulation/valuation?
We look at two measures:
stock market valuations of firms which own such capital (X)
market valuation of the physical capital, at replacement values (K)
2
Market value of corporate equity/Gross product of corporate business
2.15
1.95
1.75
1.55
1.35
1.15
0.95
0.75
0.55
0.35
1951
1956
1961
1966
1971
1976
1981
1986
1991
1996
2001
3
3.5
3.2
2.9
2.6
2.3
2
1.7
1.4
1.1
0.8
0.5
1951
1956
1961
1966
1971
1976
1981
1986
1991
1996
2001
Corporate capital stock / Gross product of corporate business
Market value of corporate equity/Gross product of corporate business
Market value of corporate equity + debt/Gross product of corporate business
4
Averages over long periods
K/Y
X/Y
1951-60:
1.92
1.40
1960-72:
1.72
1.61
1973-85:
2.00
0.82
1985-01:
1.67
2.5
Correlation(K,X) = -.73
Average X/K = .92
5
This makes no sense in the standard model
In fact, it is hardly consistent with any model in which firms are made
up by matching together physical capital, K, workers, L, and some kind
of enterpreneurial or organizational factor, Z.
In this case one would expect that
X = Value (K+L+Z) > K
Instead, in the data, the long-run evidence is that
X = Value (K+L+Z) < K
6
ln [Gross product of corporate business(per capita)]
5.4
5.2
5
4.8
4.6
4.4
4.2
4
1951
1956
1961
1966
1971
1976
1981
1986
1991
1996
2001
7
Tobin’s q = X/K
Market Value of Corporate equity / Replacement value of corporate
capital
2.2
2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
1952
1956
1960
1964
1968
1972
1976
1980
1984
1988
1992
1996
2000
8
It seems that, in the long-run, we have
q = X/K < 1
which has interesting implications for people that like the cost-ofadjustment model …
- costs of adjustment are negative, but wildly oscillating over time
- organizational capital is also negative most of the time, but it was
positive in the last two decades, and in the 1960s
9
Look at K/Y and X/Y separately.
Are there models consistent with each of their behavior, independent
from the other?
To a first approximation, the answer is Yes.
The ratio K/Y seems consistent with the standard capital-accumulation
model if one allows for sudden and unexpected changes in underlying
TFP growth rate.
The ratio X/Y seems consistent (but to a lesser extent) with the
Gordon/Lucas evaluation model, with drastic changes in the expected
growth rate of dividends.
10
Per capita Gross Product of Corporate Business (Growth factors,
relative to trend)
1.5
1.4
1.3
1.2
1.1
1
0.9
0.8
0.7
0.6
1951
1955
1959
1963
1967
1971
1975
1979
1983
1987
1991
1995
1999
11
Look more carefully at the two separate explanations.
TFP PATTERNS
1960-1972
3.0%
1973-1985
1.1% -- 1.4%
1994-2000
2.5% -- 3.0%
CORPORATE GDP PATTERNS
1960-1972
3.1%
1973-1985
2.3%
1994-2000
3.1%
12
Explaining K/Y movement with TFP movements
u
discount factor
  0.96 ,
depreciation rate
  0.08,
c1  1
; y  A1 K  L1
1
share of capital
risk aversion
  0.35,
  0.7
In this model, K  X , so no chances of explaining the differential
behavior of the two ratios.
t 1
t
Concentrate on K/Y ratio as a function of  , the growth rate of TFP
factor A.
K



Y (1  r )  (1   )
13
Results of simple calibration
Normalize the K/Y ratio during the 1960-1972 period to equal one
1973-1985
1994-2001
MODEL
(K/Y) = 1.14
(K/Y) = 1.12
DATA
(K/Y) = 1.14
(K/Y) = 0.95
14
Explaining X/Y movements with profits movements
Notice that what makes X/Y behave differently from K/Y must be a
relative price effect.
We call this the price of installed, or matched, capital, to keep the
reference with the cost of adjustment model.
Think about what this “price” could be in reality.
Two sectors? Matching? Enterpreneurial rents? Animal spirits? Risk?
Use the simplest model of dividend evaluations, with dividend set equal
to the share of capital in corporate income.
15
The simplest model is Gordon’s which gives
Pt
1

Dt r  
Dt   t (1   )t
In a general equilibrium context (Lucas’ tree model) we have
r
(1   )

So, the growth rate of TFP has a contrasting effect on the relative
valuation of installed capital, depending on risk aversion. For risk
aversion levels in (0,1), P increases with TFP growth.
Question:
if TFP growth rate drops as it did post 1972, do we get a realistic drop
in P?
16
Percentage change in the price of capital
40
30
20
10
0
-10
-20

-30

-40
-50
-60
-70
-80
-90
-100

0.4
0.5
0.6
0.7
0.8
0.9
1
1.1
1.2
1.3
1.4
17
Question:
if TFP growth rate increases as it did post 1992, do we get a realistic
increase in P?
Yes, No …
It depends on how large the 1998-2000 bubble component was …
Going back to the pre 1972 growth rate of corporate capital income
gives us an almost two-fold increase in the price of capital, relative to
its 1973-1985 level. But not a threefold!
18
Other approaches in the literature
- q-theory … does not work
- Hall organizational capital … a negative organizational capital?
- McGratten-Prescott: taxes … timing is completely wrong, and
cannot explain the differential behavior of x and k
- IT-revolution, Jovanovic et al. Cannot explain behavior of x/k,
cannot explain the stagnation from 1975 to 1986, cannot explain
the big increase post 1986, cannot explain the fact that the value of
equities in private and public firms behaved similarly post 1974,
cannot explain the behavior of consumption since 1974 …
- Increased uncertainty, two sector, putty-clay, etc ….
Nothing seems to work!
19
1.11
1.1
1.09
1.08
1.07
1.06
1.05
1.04
1.03
1.02
1.01
1
0.99
0.98
0.97
0.96
0.95
0.94
0.93
1950
1954
1958
1962
1966
1970
1974
1978
1982
1986
1990
1994
1998
Consumption per capita (excluding durables, relative to its 1950-70 trend)
Moving Average of Consumption per capita (excluding durables, relative to its 1950-70 trend)
20
200201
200001
199801
199601
199401
199201
199001
198801
198601
198401
198201
198001
197801
197601
197401
1.2
197201
197001
196801
196601
196401
196201
196001
195801
195601
195401
195201
Total credit market assets held by the rest of the world
(Relative to its 1952-71 trend)
197301
1.1
1
0.9
0.8
0.7
0.6
0.5
0.4
21
Federal funds rate
2001
1999
1997
1995
1993
1991
1989
1987
1985
1983
1981
1979
1977
1975
1973
1971
1969
1967
1965
1963
1961
1959
1957
1955
Interest rates
8
6
4
2
0
-2
-4
AA corporate bonds
22
- New listing effect: The market value of corporate equity to gross
product of corporate business may change if the output produced
in public firms, relative to that of private firms, changes.
The value of private firms and the value of publicly traded ones has
changed in the same proportion for the last 50 years. Thus, a
measure of this effect would be the difference between the aggregate
ratio VS and those for public and private firms
t
t
Figures below illustrate that this effect can account for very little of
the movements in the market ratio x from 1960 to 1985. From 1985
to 1999 the new listing effect becomes more important. Relative to
their 1960-72 average, the market value of public and private firms
had increased 50% by 1999, while VS roughly doubled.
t
t
Thus, one half of the total increase in the market ratio x that started in
the mid 1980's can by accounted by the new listing effect. But this
leaves all the rest still unexplained.
23
Market value of corporate equity (Ratios relative to their 1960-1972 average)
2.2
2
1.8
1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999
Market value of corporate equity/Gross product of corporate business
Market value of corporate equity/Corporate business receipts
24
2
1.9
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
1951 1954 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999
Market value of domestic firms listed in compustat/Sales of domestic firms listed in compustat
Market value of privately held firms / Sales (non traded, aprox calculation)
Market value of corporate equity/Corporate business receipts
25
Are factor share really constant?
Many people claim they are.
Aggregate, economy-wide data are often used, including the public
sector, small firms, etc, which are not valued by the stock market,
But evidence is mixed when you look more carefully sector by sector.
Evidence that factor shares do move quite a bit over time becomes
strong when you zoom into the corporate sector.
26
CHANGES IN THE CAPITAL'S SHARE OF CORPORATE INCOME
( Average 1960-72=1 )
1.06
1.05
1.04
1.03
1.02
1.01
1
0.99
0.98
0.97
0.96
0.95
0.94
1950 1953 1956 1959 1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001
27
Conclusion
We seem to have a problem here.
In fact, we seem to have a huge problem.
Maybe markets are crazy … but lots of evidence suggest they are not
Maybe markets are hyper-sensitive, and a bit myopic. Possibly so.
… and, maybe, income distribution does matter for the stock market.
28