GDP and Importance to Investors

What does that mean, if anything, regarding the future return on your investment portfolio?

Every three months, the U.S. Bureau of Economic Analysis releases its Gross Domestic Product (GDP) report. Last Friday (February 28, 2014), the report indicated that the GDP growth rate for the last quarter of 2013 was 2.4% annualized. This was viewed as a disappointment since economists had predicted a growth rate of something closer to 3%. What does this mean for an investor?

What is GDP?

The GDP measures the size of the economy by totaling the value of all goods and services produced during a specific period of time. The GDP for the United States in 2013 as measured on December 31, 2013, was almost $16 trillion. There are three ways to calculate GDP and all should result in approximately the same value. The three approaches are: expenditures of all sources; income generated; and total production value. The expenditure approach makes the assumption that purchasing of goods and services by all entities is a gauge of the goods and services produced. Therefore, the expenditure approach adds consumers spending, business investment, government spending, and net exports of goods and services.

What are the implications of the GDP Growth Rate?

The GDP growth rate reflects the change in the inflation-adjusted GDP dollar value from one time period to the next and, therefore, indicates how fast or slow our economy is growing. A positive percent means that the United States produced more than it did the previous period. If the country is producing more, then additional workers are employed, more services and manufacturing products are consumed, and potentially more profits are generated for shareholders. Hence, stock prices have reason to increase.

A negative percent means that our country as a whole produced less. Producing less would indicate that our economy is declining or shrinking. Service businesses and manufacturing firms are creating less products, which translates to needing fewer workers and in many cases, producing less income for investors. Stock values would potentially go down.

A negative GDP growth rate for two consecutive quarters is one of the factors used to determine that our economy is in a recession. During our last recession in 2008-09, the GDP growth rate was nearly -4% in the third quarter of 2008 and over -8% in the fourth quarter.

The economists believe that a healthy economy is one that has growth in the range of 2% to 4%. The higher, the better? Actually, no. If the growth rate spikes over 4% it is considered too high and the economy can potentially become "overheated". This means there is too much money chasing too few real growth opportunities. A bubble in value can be created. This happened just before the 2008-09 financial crisis. Home values became "overheated" and a bubble in value resulted. The GDP growth rate spiked over 4% during multiple quarters prior to the downturn in 2007.

Investor Perspective

While GDP growth rate is a good predictor of the potential movement in stock prices, the data is not received in a timely fashion. It can take two months for the numbers to be generated and reported to the public and then the numbers may be revised later. This makes the GDP growth rate a good "explainer", but not necessarily a good "predictor" of stock market movement.

For some indication of investing value, look for a positive trend in the GDP growth rate. If the economy can be growing between 2% and 4% and other market pressures remain relatively normal, i.e. value of dollar, global competition, etc., then there is a good chance the stock market will likewise reflect a positive trend.

Summary

Knowledge is a valuable resource when investing over the long term. A clear understanding of our country's GDP, its make up, and its implications for the investment community is just one more piece of information that can provide insight into how our domestic investment markets are a reflection of the greater economy.

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