Stocks and Bonds for the Long Run
Data and text in this post taken from the chapter House Prices, Stock Returns, National Accounts, and the Riksbank Balance Sheet, 1620–2012 in the book Historical Monetary and Financial Statistics for Sweden, Volume II.
- The long-run evolution of Swedish financial market returns over the past one hundred and fifty years
- The short-term risk-free rate of return is presented from 1856 and a representative long-term government bond yield from 1874
- A preliminary version of a new annual stock price and returns index for the period 1870–2012, using previously unexplored evidence of historical stock prices, dividends and equity capital from the last decades of the 19th century
Post 1: History of the Swedish Stock Market
“The Swedish stock market emerged gradually during the second half of the 19th century. One of the largest brokers in Stockholm was mandated by the City in 1863 to hold the first auction of securities; this is generally considered to be the foundation year of Sweden’s largest stock exchange, the Stockholm Stock Exchange. At that time there was a growing demand for organized trading in financial securities, primarily stocks and corporate bonds. In the initial years, no governing authority closely directed the business activities on the Exchange. In 1866, however, the City of Stockholm set up the Trade and Shipping Commission (Stockholm stads handels- och sjöfartsnämnd), which exercised the supreme operative and regulatory control of the Exchange. Auctions were held only once a month until 1895, after which they became weekly. Securities auctions were also held in some other cities but, as shown by Algott (1963), these market-places never accounted for an important share of Sweden’s total securities trading.
The trading framework on the securities auctions was such that buyers and sellers submitted their orders to the responsible broker in good time before the monthly auction. Then, at the auction, the broker declared the orders one at a time, followed by an opportunity for investors to either accept the trade or offer either higher or lower bid or sell orders. The broker then recorded the number and value of traded securities. Trading activity was relatively slight at first. Figure 6.1 shows the value of traded securities (stocks and bonds) as a share of market capitalization from the beginning of the Exchange’s practices to the present day. As can be seen, trading activity was relatively low in the 19th century and in the middle of the 20th century, and relatively high during the early and late 20th century.
As Sweden’s industrialization gradually took hold during the last decades of the 19th century, many new corporations issued stocks to a growing population of investors. This led to demands for a more organized market for securities trading. The monthly, and in the late 1890s weekly, auctions without a fixed list of shares or firm rules for pricing were clearly not sufficiently continuous for the market participants. Algott (1963) refers to the contemporary critical discussions. For this reason, the Stockholm Stock Exchange was thoroughly reorganized in 1901. The new trading structure was largely copied from the Copenhagen Stock Exchange, except that the existing auctioning system was retained, in contrast to Copenhagen’s dealership market. Trading in Stockholm was conducted by the head of the Exchange, who called out the registered stocks in a predetermined order. When a stock was called out, all market participants were able to state the levels at which they were willing to buy/sell (bid and ask quotes). When a bid and an ask level matched, a trade was registered and the transaction was completed.
Under the new framework, trading was confined to listed securities. Listing was contingent on approval of a written application submitted to the board of the Stock Exchange, containing detailed information about the security (e.g., articles of association and the latest audit report). Moreover, only brokers certified by one of the City’s councils were allowed to broker deals on the Exchange. The Exchange’s membership was small initially, only a handful or so during the first five years, but when membership was extended to banks in 1907, it rose to more than 20. Trading initially took place three times a week; daily auctions were introduced in the 1910s. Several stock price lists were published in this early era. Before 1912, the Exchange did not compile an official price list; instead, brokers and banks published their own lists in newspapers (Algott, 1963, pp. 121f).
When the First World War started in 1914, Sweden left the international gold standard and the Stockholm Exchange closed down for three months (August 3rd to November 3rd). Leaving the gold standard, combined with an initial boom in the export-oriented domestic industry, led to a higher rate of inflation in Sweden during the war. This inflation boom was one of the factors behind a remarkable increase in trading activity on the Exchange during these years; stocks are normally one of the few forms of inflation-proof investment. The increased economic activity spurred increased volumes of new equity issues, which were at century-high levels (2–4 per cent of total market capitalization) during this period (Waldenström, 2004). Figure 6.2 presents the evolution of market capitalization as a share of GDP from 1870 to 2012. The increased activity also attracted new market actors; the number of stock exchange member firms increased from 20 in 1908 to 28 in 1914 and 46 in 1921. After the war, however, the spectacular bull market turned into a devastating crash when Sweden joined the gold standard at the prewar parity, which set off a deflationary spiral and plummeting stock prices.
The spectacular wartime bull market also inspired politicians in Parliament and the liberal-socialist government to finally incorporate the Swedish stock market in the national legislation. Acts passed in 1919 and 1920 formally regulated both the financial intermediaries dealing and trading in stocks and the Stockholm Stock Exchange. One important change was that the government took charge of appointing the Exchange’s board. Moreover, the right to establish new stock exchanges was restricted. In practice, though not formally, the Stockholm Stock Exchange acquired a monopoly of organized securities trading in Sweden. This legislation remained intact until the end of the 1970s and the Exchange’s monopoly status was not abolished until 1992. Thus, the legislative changes in 1920 were of immense importance in the long run.
Another consequence of the First World War and the postwar global depression, which greatly affected the Stockholm Stock Exchange, was the economic crisis in Sweden in the early 1920s, when industrial production almost halved. The government launched a devastating deflationary monetary policy in order to bring the exchange rate back to the same level in relation to gold as during the classic gold standard. On top of this, Swedish commercial banks faced a period of systemic financial distress caused by the economic depression.
The early 1930s was another turbulent period that affected the Stock Exchange. Great Britain’s departure from the gold standard in September 1931 caused both economic and political problems in Sweden. The discount rated was doubled in a few days and the Stockholm Stock Exchange actually closed for three weeks. In 1932, by far the largest industrial conglomerate in Sweden failed in an enormous debt scandal with both governmental and international connections. This was the infamous “Kreuger Crash”, named after the conglomerate’s owner Ivar Kreuger, whose suicide in Paris on April 12th initiated the crisis. His holding company, Kreuger & Toll, owned large blocks of shares in all the main Swedish industrials.
After the Kreuger crash, the Swedish stock market was stagnant. Trading activity decreased and new listings were few. The Second World War put an end to Sweden’s relatively unregulated financial markets. Wartime mobilization and the effect of disrupted patterns of trade gave rise to an increased need for public funds, which necessitated a series of new laws to regulate the credit and financial markets. Banks and other financial market actors were required to offer funds to the central government. Furthermore, strict controls were imposed on cross-border capital flows.
In the history of the Swedish stock market, the postwar period up to roughly 1980 was on the whole relatively quiet. The wartime credit and capital market regulations were intact. Credit markets were entirely controlled by state authorities, especially the Riksbank, Sweden’s central bank. Stock-exchange trading activity was relatively low. For these reasons, the period is sometimes described as a “financial ice age”. At the same time, the Swedish economy performed well, with annual real per capita GDP growth at 2–3 per cent. Swedish companies were highly profitable and could meet most of their financial needs from retained earnings. Consequently the stock market became relatively unimportant as a source of funds. About 40 new companies floated their stock on the exchange in the 1950s and early 1960s, which brought the total number of listed companies up to 115. In the following decade, however, the number decreased by 20 (Boman, 1988). In these decades the valuation of the Swedish stock market was very low. Some of the main factors behind this weak development were no doubt the strict rules for issuing and floating new shares, listing and participation in trading at the Stockholm Stock Exchange.
In the 1970s, financial innovations aimed at increasing stock market turnovers were introduced in the Western world, including Sweden (see Werin, 1993). One of the major moves was the introduction of computers in trading systems. More trades were executed at a faster pace and more customers were able to acquire exchange information and submit trades thanks to the wider outreach of brokerage firms and banks.
In 1980 Sweden was still a highly regulated economy with virtually no stock market activity, regulated capital and credit markets, and a debate about “wage-earner funds”, a scheme designed to shift corporate ownership to trade unions by way of higher corporate taxes. All this changed dramatically largely through a series of reforms, starting with the deregulation of capital markets and international capital movements in the 1980s, tax reforms in the mid-1980s and early 1990s and an end to the idea of wage-earner funds in the early 1990s. As a result of technological developments and the reforms of Swedish financial markets, of which the deregulation of credit and currency in the latter half of the 1980s was the most important, the Swedish stock market boomed. In the 1980s the stock market index rose twelvefold, or four times as much as the Dow stock index in the US. The boom attracted both new capital and new actors. By 1997, 352 IPOs were registered on the Stockholm Stock Exchange, a dramatic increase from the low levels in earlier decades (Holmén and Högfeldt, 2005). A derivatives market, OM (“Optionsmäklarna”), also emerged in Sweden in the second half of the 1980s. This market enabled investors to trade a number of new financial instruments, such as options and warrants, which offered insurance mechanisms as well as new investment opportunities that did not exist on the Stockholm Stock Exchange.
Further important changes occurred on the Swedish stock market in the 1990s. In 1993, trading was opened up for non-residents, which led to an increase in foreign ownership of the exchange-listed stocks from a few per cent to forty per cent in the course of a decade (Henrekson and Jakobsson, 2012). Another change was the formal end to the Exchange’s trading monopoly, allowing securities trading to take place elsewhere. Other market actors organizing trading started to grow and in 1998 the Stockholm Stock Exchange was acquired by the largest of the private actors, OM, forming the OM Stockholm Stock Exchange (“OM Stockholmsbörsen”). As a consequence, the exchange ceased to be a semi-public market place and became a privately owned for-profit company selling products associated with securities trading.
In the early 21st century, the OM Stockholm Stock Exchange expanded by purchasing the Helsinki Stock Exchange in 2003 and changed its name to OMX. In 2005 OMX acquired the Copenhagen Stock Exchange and in 2006 the Iceland Stock Exchange. In 2008, OMX was itself purchased by Nasdaq, which gave the market-place its current name, NASDAQ OMX Nordic. These organizational changes have not involved any dramatic changes in securities trading on the Stockholm stock market. The new owners have, however, introduced several new features, including new lists containing various selections of Nordic securities as well as separate listings for small-, middle- and large-sized companies in terms of equity capital.