GDP.
The letters stand for gross domestic product, but what even is gross domestic product?
And what does it mean for investors?
Gross domestic product is nerd speak for adding up the value of all the finished goods and
services in a country’s economy over a certain time frame.
Well, it’s all the goods and services minus what it takes to produce those goods.
GDP helps economists keep an eye on how the economy is doing.
But GDP matters to investors too.
Although the stock market is not the economy, healthier economies tend to have healthier
investment returns.
So let’s break down what actually makes up GDP.
The equation looks something like this: Consumption + investment + government spending
Â± net exports
Start with consumption: things like your neighbor’s ugly pickup truck or your dunkies coffee.
(You know you love your coffee).
Coffee.
Take the value of all the material goods and services and add them up.
This makes up more than half of the equation.
This part of GDP is typically the most tethered to the stock market; these products lead to
sales, which turns into revenue and profits, which if things are going well tend
to lead to returns for investors.
Then add investment: things companies spend money on.
Think real estate and equipment.
Home building and intellectual property fall under investment too.
If Starbucks buys more efficient coffee grinders, that would fall under this category.
Next, add government spending: think teacher salaries, road repairs, military spending
and farmer subsidies.
Then you’ve got net exports.
That’s goods we send abroad minus goods we buy from abroad.
So, if we exported $500 billion of goods, but we imported $700 billion, our net exports
would be $200 billion in the red.
No, no, that’s ok.
It’s total normal.
A lot of countries import more than they export.
As of September 2021, the Unites States imported $80 billion more than we exported.
All of these things are added up quarterly by governments; in the United States, it’s
the Bureau of Economic Analysis.
It’s not uncommon for their calculation to be revised when new quarters are calculated.
The American GDP was $21.5 trillion for 2020.
That’s a huge number.
Like, too big to comprehend.
So, economists often use a different number, the percentage of growth, to gauge whether
things are moving in the right direction.
Take a look at this chart.
It’s up and down, right?
The GDP grew 2.1 percent last quarter is much easier to understand than the GDP
was 21.7 trillion bucks.
Shrinking GDP is one indicator of the r word (recession).
That’s a significant decline in economic activity lasting more than a few months, often
accompanied by high unemployment and tumbling financial markets.
One popular definition of a recession is GDP shrinking for two consecutive quarters.
By that definition, between 2000 and 2021, there were three recessions: the dot-com bubble,
the Great Recession, and the start of the COVID-19 pandemic.
So how does any of that actually matter to your portfolio?
Well, on a macro level, significant changes in the economy can upend the stock market.
Typically, when the economy suffers, so do corporate earnings, which is the primary basis
of the stock market.
Lemme break that down a little bit further: Whatever is affecting the broader economy
is probably affecting the companies within that economy too.
If an economy is growing, that means consumers and investors have a bigger slice of the pie
to spend, and that can translate into earnings.
But GDP won’t really give you any insights to sector allocation or stock selection; it’s
old news.
The stock market is very forward-looking, and GDP is based on past performance.
It’s a lookback at how everything fared over previous quarters.
In the early days of the pandemic, the global economy basically got mugged in an alleyway.
In February and early March 2020, the S&P 500 took a hit of more than 30%.
While GDP was down a little that quarter, it wasn’t until Q2 that it tumbled.
Because GDP was released after the markets had a tumultuous couple of months, you can
think of it as a kind of report card.
Nerds call this a lagging indicator.
One way investors can use GDP is to determine where we are in the business cycle.
There’s a traditional cycle sectors rotate through as the economy grows.
When the economy emerges from a recession, one of the first sectors investors usually
move to is financials think banks, brokers, and insurance companies.
Then, investors typically rotate into the tech sector, and so on.
Keeping an eye on GDP can give investors a sense of which sector might be the next to
grow.
If you’re considering investing in a company overseas, GDP can provide a broader picture
of that company’s home country.
If GDP is contracting, that could mean poor prospects for the company, and it may make
it difficult for its stock to outperform.
All of this is a long way of saying GDP is an important economic indicator, but the ways
you might use it in your own investing depends on your investing strategy.
It can provide an overall picture of a nation’s economic health, which can ultimately impact
stocks, but news about GDP typically doesn’t move markets.