A macro explanation of high US stock valuations

Last week, I wrote about a proposed method to improve the forecasting power of the cyclically adjusted P/E-ratio (CAPE). Meanwhile, the high valuations of the US stock market vex many economists and investors alike. Could systematic shifts in the US economy be to blame?

One trend in the US economy has been the declining share of labour in the economy. Capital has increasingly replaced labour as an input and driver of corporate profits. This shift from labour to capital has happened right about the same time as US stock market valuations have started to lift off, Andrew Atkeson and his colleagues show with the chart below. The chart shows free cash flow generation of US businesses relative to their profits (Gross Value Added, GVA) in blue. The red line shows one minus the compensation of employees over GVA. As compensation for employees declined, more cash remained available to shareholders.

Cash generation increased as labour compensation declined

Source: Atkeson et al. (2026)

But if there is more free cash flow to shareholders, the valuation of the company increases even when profits remain constant. Ergo: valuation multiples increase and remain permanently high.

Or rather, they remain high as long as nothing changes, which brings me to the question of why the labour share of GVA or the labour share of the economy has declined so much.

Atkeson and his colleagues give several possible explanations:

• Investment is mismeasured in the economy, and somehow, there has been a major increase in investments in things like intangible capital that are hidden from standard macro measurements.

• Employee income is mismeasured. More and more employees are compensated through corporate stocks and stock options, which do not count as labour income and may thus lead to an underestimation of the labour share in the economy.

• Companies in certain industries like social media, AI, and other tech spaces have become virtual monopolies and exploit these monopolies (or oligopolies) to extract rent from customers to generate supernormal profits.

Personally, I am on the record for favouring the third option, since something that has become obvious is that companies like the Mag7 in the US enjoy profit margins that are way above normal levels and are no longer mean-reverting because there is no competition emerging that could undermine their profit margins. If there is a competitor that could become a danger, the big tech companies tend to simply buy that rival, thus creating a kill zone around them.

Plus, Cory Doctorow’s Enshittification thesis claims that, besides the lack of competition, a lack of antitrust enforcement has enabled these companies to lock in both consumers and advertisers, thus creating virtual monopolies that they can extract to the benefit of the owners of these companies.

This third driver also explains one crucial shortcoming of the analysis of Atkeson and his colleagues. They only look at the US stock markets and the declining labour share in the US. But as we know, the labour share has declined in the vast majority of all major economies, yet only in the US are stock market valuations untethered from long-term averages. The main difference between the US and these other countries with declining labour shares is that only the US has tech companies that are globally dominant.