The 1990s were exceptionally good years for stock market investors. The Standard and Poor's 500 index, which measures the value of the largest 500 firms, increased eight years during the decade and climbed 15 percent per year on average. Many observers have noted that the '90s' stock market boom coincided with a surge in the number of households that owned stocks—either directly or indirectly—through mutual funds, retirement accounts and other managed assets. As the accompanying chart shows, the stock market participation rate rose sharply from 32 percent in 1989 to 49 percent in 1998. Did this large influx of new investors propel the decade's stock market boom? Economic theory suggests that if an increase in the number of shareholders spreads stock market risk over a larger pool of investors, then the rate of return required to compensate shareholders for their risks ought to fall. This would cause a one-time increase in stock prices.
It is tempting, then, to argue that the increase in stock market participation played a significant role in the recent boom.
However, a closer examination of the data shows that most new shareholders own a relatively small amount of stocks.
The accompanying chart also reveals that the share of stocks held by the richest 10 percent of American households remained between 78 and 82 percent during the period between 1989-98. This means that aggregate stock-holdings remain highly concentrated in the hands of the wealthiest 10 percent. Hence, the argument discussed above does not apply because even though the number of shareholders increased, a relatively small pool of wealthy investors still absorbed most of the risk.
Other explanations for the most-recent stock market boom include:
However, economists John Heaton and Deborah Lucas argue that none of these factors can explain a significant portion of the 1990s' stock market run-up. Because stock prices have been very volatile throughout its history, the recent boom might be a cyclical deviation from the trend.
It is puzzling that a large fraction of American households continue to own few or no stocks because, on average, stocks have outperformed government bonds by a large margin. In a recent issue of the Review, the Bank's economics journal, I discussed several possible explanations.
One can argue that because of the information-technology revolution, information costs have become less important for making investment decisions. The research clearly indicates that our economy's reliance on labor income and the average worker's home-ownership patterns are the primary reasons why stock ownership remains highly concentrated in the hands of a few wealthy households. Simply put, working people—who face considerable labor-income risk and have a limited ability to borrow—often choose to put their savings into relatively safe assets instead of stocks.