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Should Investors Be Concerned that the Number of Listed US Stocks Has Dropped by Half Since 1996?

Cambridge Associates
Michael Salerno

Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.

No. The US public equity market remains the largest and most liquid in the world and continues to offer a robust opportunity set for investors. Still, factors such as larger company sizes and industry concentration impact portfolio diversification and may have long-term implications for portfolio returns. Investors should ensure they are adequately diversified and have exposure across regions, sectors, and market cap segments. Private investments can also play a role.

Although the number of listed stocks has shrunk, the number of investable stocks has been quite stable. The approximately 50% drop in the number of listed US companies since 1996 provides a stark headline, but must be put into proper historical context. Much of this was simply a reversal of the dramatic increase over the prior 15 years. A sizeable portion of the attrition is due to the disappearance of many small- and micro-cap stocks whose ranks had dramatically risen in the 1980s and early 1990s. Many of these stocks were never investable for institutional portfolios given managers’ own liquidity constraints as well as securities regulations limiting ownership stakes in public companies. Relative to January 1980, the US equity universe is down a more moderate 20%.

Data show that the United States is not unique among global equity markets in experiencing a sharply shrinking public stock universe. Among major developed markets, France’s stock count is 59% below peak; the United Kingdom, 36%; and Germany, 30%. Some emerging markets have suffered even greater declines. The only region globally to experience a growing public stock universe has been Asia, led by China, which now has over 3,000 listed companies, nearly six times the number of public stocks it had in 1996.

The bigger question may be to what extent has the shrinking number of stocks impacted each country’s investable universe? Here, it’s useful to look at the country composition of the MSCI All Country World Investable Market Index (ACWI IMI), which consists of 8,653 stocks and covers 99% of the world’s equity market capitalization, according to MSCI. Today, the index has 2,432 US stocks, 2% higher relative to 2002. By comparison, for example, the number of investable UK stocks has shrunk 14% over the past 15 years. US stocks now compose 28% of the index’s total constituent count, nearly in line with their 29% average since 1994. In contrast, though developed ex US companies currently account for 41%, this is below their historical average and substantially lower than their peak.

In other words, the number of investable US stocks has actually been quite stable, but the developed ex US universe has been shrinking at the expense of a growing number of investable stocks in emerging Asia, which now commands nearly one-quarter of the total universe. With emerging Asia also composing a growing portion of the global investable universe from a market cap standpoint, investors must ensure they are not structurally underweight this dynamic region.

The United States remains the largest stock market in the world and currently represents 52% of the ACWI IMI’s total market capitalization. Furthermore, the aggregate market cap of the US market has never been higher. Its average market cap has grown from US$2.2 billion in 1996 to US$11.3 billion today, and its median market cap has grown from US$0.5 billion to US$2.2 billion. By contrast, the average and median market caps for global ex US companies remains lower today at US$4.1 billion and US$0.9 billion, respectively.The reasons for this are twofold. First, the investable US market has outperformed global ex US equivalents by over 250 basis points (bps) annualized over the past 21 years (starting January 1997), including by almost 600 bps in the ten years since January 2008. This has been driven in part by superior earnings growth in the United States but also by a larger increase in valuations. Second, acquisitions of private companies by public firms have added to the public market’s aggregate market cap, particularly those involving stock-for-stock deals. From 1997 through 2017, US public stocks acquired an annual average of 815 private companies worth US$102 billion; that equates to more than US$2 trillion in acquisitions of private companies by public stocks over the full period. Although the majority of these transactions were cash deals, the aggregate contribution of stock-based mergers between public and private companies to the public market’s aggregate market cap over the past two decades has likely been non-trivial.

The robust and steady merger activity over the past two decades has increased the market share concentration of many US industries, and not just for the portion of the domestic economy that is publicly listed. However, the current concentration of most industries has not reached concerning levels. Still, it’s been a case of the big getting even larger and stronger—the winners have commanded increasingly higher profit margins, whereas the rest of the market has seen profitability decline. Arguably, the evolution of communications and information technology, as well as modern financial theory and capital markets structure, have contributed to this trend, which academic researchers Gao, Ritter, and Zhu call the “Economies of Scope Hypothesis.” They argue that the profit-maximizing decision for companies today is not a tradeoff between private and public but a question of large versus small, where the large corporation is now the profit-maximizing organizational form. Of course, one risk of ever larger firms is that it becomes increasingly difficult to sustain prior growth rates.

Investors looking for a way to implement this strategy may want to look for opportunities among the big companies that have proven most effective at integrating acquisitions and are in the process of consolidating their industries and/or their supply chains, as well as among those smaller companies with differentiated product or service offerings in industries that are ripe for consolidation. Businesses providing technology or services that can help facilitate industry consolidation present another potential opportunity, and this is one area where the private company universe may offer a particularly interesting set of ideas. Longer term, investors should be aware that a less competitive environment ultimately could mean slower economic growth for the average company to leverage and could limit future returns. Dominant companies may also attract greater regulatory scrutiny regarding anti-trust issues, as we have started to see in certain industries like internet services, and this could in turn harm profits.

Bottom line, investors shouldn’t fret the shrinking US stock universe, as this is not the same as a shrinking opportunity set. Ideally, investors should focus on ensuring their portfolios are positioned to capture value creation wherever it may reside: domestic or foreign, large or small, public or private.

Michael Salerno is a Senior Investment Director on Cambridge Associates’ Global Investment Research Team

Originally published on February 13, 2018

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