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 ± net exports Start with consumption: things like your neighbor’s
ugly pickup truck or your dunkies coffee. (You know you love your coffee). Coffee. Coffee. Coffee. Coffee. Coffee. 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.
