Context: The Retail Investor Landscape
The US Stock Market, 1980s-Present
An Unparalleled Wealth Generating Machine
The US Stock Market, 1980s-Present:
Over the past 40 years the US Stock Market has generated wealth on a scale unlike anything else before it. For instance, imagine the scenario in which you had invested $1 in the Wilshire 5000 (All US Equities) at the start of 1980. By January 2021, your $1 would have grown ~9% annually to just over $35*. Now compare that to a growth of 3.4x for inflation over the same period. Let’s just say you’d be sitting pretty.
In fact, the total US Stock Market capitalization (the cumulative value of all publicly listed American companies) has more than doubled from $15.6 trillion to $39 trillion in between 2011 to 2020. As would be expected, this unprecedented growth in the stock market has helped to mint more millionaires and billionaires than any other time in recent history. Sorry Medieval Times serfdom.
While we may perceive the 1980s as the glitzy gilded age, we currently live in a time of unprecedented wealth with no measure. From 1980 to 2020, according to Credit Suisse, the number of global millionaires grew 54x (from 1 million to 54 million), while the count of global billionaires grew by 10x (from <200 to >2000). In the US alone, there are over 11 million “millionaire households”.
In 2020 alone, Bloomberg reported the addition of an additional 56 billionaires alone. There truly is a pot of gold on the other end of every tech IPO (or SPAC) rainbow. Unfortunately, many American haven’t participated in this wealth creation, something that we will explore deeper in another post. But let’s take a look at why the last 40 years have been an unprecedented ascent of wealth, which is frankly batty.
Though there are many logical explanations for the stock market’s meteoric growth over the past four decades (i.e., population proliferation, globalization, low corporate taxes, exuberant valuations, monetary policy, etc.), there are two significant drivers we’d like to highlight in the post below— namely, advancements in trading technology and the expansion of the investor base.
Let’s walk through these concepts below in detail.
RE: Advancement in Trading Technology
While the ubiquitous effects that computers and the internet have had on American society have been covered ad nauseam, less focus has been directed to technology’s impact on the stock market. Compared to the 1970s, where buy and sell orders were still placed over the phone, logged manually, then fulfilled by brokers on a trading floor, the ‘80s-’90s witnessed a technological renaissance of electronic trade settlement and online trading.
Computers were already being used in the ’70s to track quotes and stock prices, In fact the NASDAQ, which was started in 1971, was initially set up as a alternative means to get price quotes electronically. However, by the mid-’80s, both the NYSE and NASDAQ switched from manual to electronic trade execution and settlement, where buy and sell orders were matched and processed on computers, rather than in person or over the phone. This switch greatly increased the pricing efficiency of the stock market.
Electronic quoting and trade settlement catalyzed decreases in the bid/ask spreads (the price difference between what a buyer is willing to pay for and what a seller is willing to take for a stock), along with increases in liquidity (the ease to buy or sell an investment).
Electronic trading and settlement also empowered a new breed of discount brokers, such as Charles Schwab, to encroach on Wall Street without the need for a large physical trading floor presence. Remote fulfillment and monitoring enabled a lower operating cost structure, in which discount brokers passed on savings to customers in the form of lower trade commissions.
In the 1990s, the widespread adoption of the world wide web helped bring trading to the masses. (Queue: modem churn) With the launch of online trading brokerages like E*Trade and Scottrade, retail investors could now access investment information and transact trades fully on their bulky PCs for a flat commission ($40 per trade in 1993).
Prior to this pricing structure, retail investors had to pay stockbrokers a base fee plus percentage-based commission on the transaction amount, which could add up to hundreds or thousands of dollars per trade. With fees like these, stock trading was strictly the provenance of the wealthy.
Fast forward to the 2010s and onward, technology has altered trading into a form hardly resembling anything like that in previous decades. Some highly advanced quantitative funds employ algorithms, which borrow mathematical formulas for detecting patterns in nature, to trade in and out of investments at high frequencies (less than a second). As Michael Lewis points out in his 2014 book Flash Boys, data latency and high frequency trading have become the real battle fronts in the technology enabled trading age.
For private retail investors, the introduction of Exchange Traded Funds alongside the advancements in frictionless trading has made it easier than ever to buy and sell whatever one wants. Whereas previously you would have had to dial a commodities broker on the Chicago Mercantile Exchange (home of the now shuttered trading pits featured in Ferris Bueller’s Day Off) in order to buy a futures contract for livestock, today you can simply look up the ticker COW on your brokerage’s mobile app to get exposure to the price of cattle and lean hogs.
Oh, and as of 2020 most brokerages have dropped fees to $0 per transaction.
Technology has truly catalyzed a trading revolution that has expanded access to markets and enabled investors of all haunts to trade anything they want, basically whenever they want.
RE: Expansion of Investor Base
The expansion of the investor base has also fueled the stock market’s rise since the 1980s. Over the last 40 years, the amount of capital available for investment into the stock market ballooned dramatically. Logically, the more total available capital for investment, the more of it that makes its way into the stock market. Two major drivers for an expanding investor base have been a set of retirement savings policies and the large influx of foreign investors into the US stock market.
In the 1970s, Congress passed both the Employee Retirement Income Security Act, which introduced fiduciary guidelines for pensions, and the Revenue Act, which introduced tax efficient 401(k) retirement savings plans. As a result, companies could invest their employees’ pensions and pre-tax 401(k) contributions into the stock market.
Further, in 1997 the US enacted the Taxpayer Relief Act, which established “Roth” Investment Retirement Accounts (IRAs). Roth IRAs permitted individual taxpayers to contribute post-tax earnings into an investment account, which would not be taxed capital gains upon withdrawal at the age of retirement.
All of this fresh capital sparked the rise of Mutual Funds throughout the ’80s and ’90s, as money managers eagerly sought to deploy retirement assets into the stock market and collect handsome fees in return. The amount of funds that mutual funds manage catapulted from $134 billion in 1980 to $12 trillion in 2019.
In aggregate, these retirement savings plans have flooded the stock market with capital. US retirement assets grew from less than $1 trillion in 1980 to nearly $39 trillion in 2019. Since 2005, US IRA Assets alone have grown from $3.4 trillion to $11 trillion at a compound growth rate of 8.7%, more than tripling in size.
In addition to the boon of domestic capital available for investment, an influx of foreign capital into the US has also had a profound impact on the stock market. Foreign investors have increased their participation in the US equity markets, powered by increasingly open capital markets and near instantaneous trading technology.
As poorer nations have become prosperous nations over the past 40 years, and the US has largely outperformed most other countries in terms of innovation, foreign investors have looked to gain exposure to the US Stock Market. According to Goldman Sachs, while foreign investors held about 6% of the US equities in 1980, they now hold 16% in 2020. This amounts to an overseas influx of approximately $4 trillion dollars over this period into the US stock market.
This flow has been compounded as large foreign companies, like Alibaba (Ticker: BABA) with its $800 billion market capitalization, have listed their shares for public trading on US stock exchanges. And though the US market has seen periods of high volatility over the past 40 years, many foreign investors largely see the US as a safer bet for risk-adjusted returns in comparison to their native markets. At no time was this more pronounced than during the Global Financial Crisis, when foreign investors flocked to the US dollar and US Treasuries as a safe haven.
This inflow of assets has had a profound impact on who controls the US equity market. With the rise of institutional investors (such as mutual funds and ETFs) and foreign investors, the composition of direct ownership of corporate equities has shifted away from US households directly. In 1980, US household held approximately 60% of the equity markets — in 2020, this proportion has shrunk to 35%.
While this number seems drastic, what’s important to note is that US households are still the primary beneficiaries of corporate equity ownership, and this value has ballooned dramatically. The Federal Reserve Bank of St. Louis reported that household ownership of corporate equities and mutual funds has grown from $1.4 trillion in 1987 to $29.1 trillion in 2019.
In sum, the US Stock Market has proven to be an unparalleled wealth generating machine over the past 40 years, creating a new gilded age.
The advancements of trading technology and the vast expansion of the investor base have been two key drivers to the stock market’s growth. What’s more is that as trading technology has increased access to the US stock market both domestically and internationally, the resulting influx of capital has led to more trading volume, climbing valuations, and sustained periods of price appreciation.
As returns have stayed consistently high over the past 40 years, they have created a psychology that over the long run the US market is infallible. This mindset spurs investor appetite to continue buying equities, which begets more returns, and thus engenders a largely circuitous cycle.
But the market is also subject to great shocks and pullbacks, as evidenced by some of the most volatile days of trading ever recorded back in March 2020. These can be times of great pitfalls for both Main Street and Wall Street Investors.
And while millions of US households have benefited tremendously from the stock market’s growth, especially in 2020, many more millions have not. Why not? We’ll take a broader look at stock market participation and the state of retail investing in 2021 in our next post.