Six Facts about Stock Market Capitalisation

There are about a hundred countries in the world with national stock markets. According to the World Bank, in 2022 (more recent data are unavailable), the median of their capitalisations reached 34% of GDP (i.e., in half of the countries, it was more, and in half of the countries, it was less than this size), and the average size was 75% of GDP. The current ratio of Russian market capitalisation to GDP is around 34%. This corresponds to the level of Latin America, particularly Brazil, but it is lower than that of Southeast Asia (64%), and also of the upper middle-income (66%) and high-income (131%) economies in the group in which the World Bank has included Russia.

In May 2024, the Russian president signed an executive order (link in Russian) on national development goals until 2023. The document sets the objective of raising the capitalisation of the stock market to 66% of GDP by 2030. This corresponds to the level of capitalisation in China (64%), while it is lower than that in India (107%), the UAE (172%) or South Africa (289%) (all data for 2022). As of now, there are several pending questions, such as whether and how it is possible to determine a reasonable depth of the stock market, what are the factors of capitalisation growth and which policy interventions promote the growth of capitalisation. Certain answers can be provided by economic science, the observation of capitalisation in other countries, and the current structure of the Russian stock market.

Capitalisation plays a significant role in households’ income and consumption. In macroeconomic analysis, there is a concept of a ‘wealth channel’. Strictly speaking, economists view it as the pass-through of the central bank’s policy rate to consumption expenditure through changes in the value of household financial assets. In a broader sense, this concept explains how savings income affects economic growth and inflation. It is important to understand that growth in savings results in higher income from them, which in turn leads to an increase in consumption. All this means that the stock market can potentially increase household consumption. Long-term and sustainable growth of capitalisation improves the living standard of people through the wealth channel.

The life cycle hypothesis (consumers smooth their expenditure over their lifetimes, first by accumulating savings and then by spending them) describes the behaviour of roughly 75% of the population. While savings typically influence the consumption of the wealthy or the elderly, the involvement of retail investors in the equity market allows for broader effects. According to the Moscow Exchange (link in Russian), 33 million people in Russia have brokerage accounts, and retail investors account for about two-thirds of equity trading.

Capitalisation is determined by two variables: the number of issuers and their shareholder value. The former depends on initial public offerings (IPOs), while the latter depends on share prices.

The roles of both variables change over time. Between 1870 and the 1980s, capitalisation in the advanced economies grew in absolute terms in line with GDP. However, it was at a steady level in relative terms. Thanks to ‘The great reversals: the politics of financial development in the twentieth century’, a 2003 paper by Chicago economists Raghuram Rajan and Luigi Zingales, we know that, notwithstanding economic cycles, capitalisation has always returned to its long-term level of one-third of GDP. Over decades, it depended on the number of issuers, while increases in share prices tended to zero in real terms. A fundamental change occurred in the 1990s, first in the developed and then in the developing economies. Since that time, the ratio of capitalisation to GDP has tripled and continues to slowly move upwards. In the first quarter of the 21st century, growth has been caused by price bursts rather than by an increase in the number of floating shares.

Interest in the stock market has been fuelled by the ‘democratisation of finance’ (link in Russian). This is a reduction in the role of financial intermediaries, an expansion of the number of participants due to an increase in retail investors, the reduction of the average ‘cheque’ (transaction size), and the introduction of mobile technologies for market access. In the 1980s, wealthy clients usually called their brokers, and the brokers charged considerable flat fees for each transaction concluded by phone. In the 2020s, investors press buttons in mobile applications on their smartphones and make transactions themselves with no or very low fees. The ‘democratisation of finance’ has brought millions of non-professional investors into the market. The peak occurred in the pandemic year of 2020, when, with investors bored by quarantine, world market capitalisation reached 133% of global GDP.

Throughout the 19th and most of the 20th centuries, capitalisation in developed economies grew due to consistently rising numbers of issuers entering the market. This is the safest way to increase capitalisation in terms of economic science. It has nothing to do with ‘bubbles’ in which share prices do not correspond to their fair values.

Many countries have achieved remarkable successes by encouraging small and mid-cap companies to go public. For example, the number of exchange-listed companies exceeds 11,000 in China and 2,000 in India. In New York, Hong Kong, and London, markets were able to expand by attracting foreign issuers. For comparison, the Moscow Exchange (link in Russian) offers the ordinary issues of 201 companies. Of these, the issues of 83 companies are traded regularly, which is less than 10% of all registered public joint-stock companies in Russia. Thus, IPOs are a relatively simple way to increase the capitalisation of the Russian market.

A renaissance of IPOs can be seen in 2023–2024, when the number of initial public offerings is hitting 10-year records (link in Russian). However, these readings are far from booming, as these are small-cap companies, and the number of IPOs ranges from 10 to 20 per year. According to the government’s plan in the Financial Market Development Strategy through 2030 (link in Russian), the number of public offerings should be between 15 and 20 per year by 2030. To understand the scale of capitalisation at 60% of GDP: last year, the number of IPOs in China was 302, while in India it was 220.

One way to resolve the issue of small market size is to privatise public sector companies. Every year, the government holds tenders to sell companies that could go through the IPO process. This process calls for certain work to be done: reorganisation into a public joint-stock company, the introduction of governance in line with the Corporate Governance Code, the compilation of IFRS reporting, the disclosure of information, the elaboration of mid-term business plans, and the establishment of relations with investors. That said, if companies were sold in the public market, federal revenues could be greater and the national wealth could be higher. Since the share of the state in GDP is steadily above 50%, privatisation seems to be one of the most effective ways to enhance capitalisation.

A large number of research papers are dedicated to the value of equity capital. There are several points of view on capitalisation or several factors affecting its growth.

First, these are institutional factors: the protection of shareholders’ rights, corporate governance that is responsible for efficiency and the absence of conflicts of interest, the disclosure of information, and the institution of bankruptcy. All of these are long-term in nature and retain their importance. It takes many years to earn investors’ trust and confidence in the future.

Second, there are economic factors, which increase issuers’ appeal to investors. These are more short-term in nature, as they include taxes, issuers’ motivation to improve profitability, dividend policies, and stock exchange listing requirements.

Third, there is the structure of the stock market: tradable assets, categories of investors (collective forms of investment most of all), pricing efficiency, and long-term strategies to manage household savings.

Fourth, there are microeconomic factors: technologies enabling access to the stock market and supporting the ‘democratisation of finance’, the management of service quality for retail investors, marketing policy for brokers, and the creation of extremely popular ‘meme’ stocks.

Of the above mentioned, the second-group factors deserve the most attention, as they are directly controlled by financial authorities and can promote the growth of capitalisation over several years.

The  majority of developed economies have experienced the explosive growth of capitalisation observed in recent decades. It has been called the largest structural shift in the entire history of the stock market. It has no connection with the pump and dump strategy. It is based on the long-term investment appeal of major issuers.

This phenomenon can be analysed with the help of the Gordon growth model, named after its creator, Myron Gordon of the University of Toronto. The model singles out three components of capitalisation: dividends (distribution policy), expected returns (economic growth), and the discount rate of future cash flows (the central bank’s interest rate policy).

The analysis by Dmitry Kuvshinov of Pompeu Fabra University and Kaspar Zimmermann of the Leibniz Institute for Financial Research in their 2022 paper ‘The big bang: Stock market capitalization in the long run’ dispels popular myths about stock market growth. Capitalisation is a signal neither of economic growth, nor of labour productivity growth. Central bank policy rates explain only a small part of the change in capitalisation. In reality, the explosive growth is a result of the re-distribution of profits in the economy in favour of public joint-stock companies. It turns out that they are more profitable than unlisted companies are. Due to their higher returns, they are able to pay higher dividends. Profitability reflects the efficiency of public issuers: higher returns are more related to increases in profits per unit of product than to increases in the market share.

It turns out that the secret of faster growth in capitalisation is simple: public issuers are more efficient than all others are. They are either more profitable or grow faster than the rest of the economy, a fact that is evidenced by their share prices. The five top issuers by market capitalisation in the global economy (Apple, Microsoft, NVIDIA, Alphabet, and Amazon) merely serve to confirm the general conclusion.

In applying this to the domestic market, local specificity must be taken into account. State-related issuers account for about two-thirds of capitalisation, and capitalisation is influenced by contradictory factors. Last year, the net financial results of companies increased by one third (link in Russian). Meanwhile, from 2025, the income tax rate will increase from 20% to 25%: on the one hand, this will rise budget revenues; while on the other hand, it will reduce net profits and, eventually, dividends. Starting from 2024, government directives (link in Russian) no longer contain standard performance indicators for joint-stock companies whose shares are owned by the state. This entails the individual assessment of issuers and the absence of comparative analysis of their performance.

Nonetheless, there remain broad opportunities to include the objective of enhancing capitalisation in the corporate governance of major issuers. If the remuneration of top management is correlated with this objective, there will be a fundamental basis for stocks to grow. Positive experience has already been accumulated, such as the obligation that state-related companies pay dividends totalling at least 50% of their IFRS profits. The issues of efficiency, profitability, and capitalisation remain out of scope.

The Bank of Russia can recommend that issuers improve market performance through the Corporate Governance Code (link in Russian). It can also encourage institutional investors to support issuers through the Responsible Investment Principles (link in Russian). However, if major issuers are not motivated to improve their own performance, capitalisation will not be able to grow by itself.