Economic Indicators: Gross Domestic Product (GDP)

The gross domestic product (GDP) is a comprehensive scorecard of the country’s economic health. As an aggregate measure of total economic production for a country, GDP represents the market value of all goods and services produced by the economy during the period measured, including personal consumption, government purchases, private inventories, paid-in construction costs and the foreign trade balance (exports are added, imports are subtracted).

GDP consists of the total value of the nation’s production and is made up of purchases of domestically produced goods and services by individuals, businesses and the government.

On a quarterly basis, GDP is often presented on an annualized percent basis. Most of the individual data sets will also be given in real terms, meaning that the data is adjusted for price changes, and is therefore net of inflation.

There are several types if GDP measurements:

•          Nominal GDP is the measurement of the raw data.
•          Real GDP takes into account the impact of inflation and allows comparisons of economic output from one year to the next and other comparisons over periods of time.
•          GDP growth rate is the growth in GDP from quarter to quarter.
•          GDP per capita measures GDP per person and is a great way to compare GDP data between various countries.

Importance for investors

Investors look at the growth rate in GDP as part of their asset allocation decision. They can also compare the GDP growth rates of different countries and make decisions about allocating their assets to stocks in these fast-growing economies.

The Federal Reserve uses the growth rate and other GDP stats as part of their decision process in determining what type of monetary policies to implement. If the growth rate is slowing they might implement an expansionary monetary policy to try to boost the economy.

If the growth rate is robust they might use monetary policy to slow things down in an effort to ward off inflation.

Real GDP is the indicator that says the most about the health of the economy and the advance release will almost always move markets. It is widely followed and discussed by economists, analysts, investors and policy makers.

The corporate profits and inventory data in the GDP report are a great resource for equity investors, as both categories show total growth during the period; corporate profits data also displays pre-tax profits, operating cash flows and breakdowns for all major sectors of the economy. The biggest downside of this data is its lack of timeliness; investors only get one update per quarter and revisions can be large enough to significantly change the percentage change in GDP.

Strengths of the GDP:

• GDP is considered the broadest indicator of economic output and growth
• Real GDP takes inflation into account, allowing for comparisons against other historical time periods
• The Bureau of Economic Analysis issues its own analysis document with each GDP release, which is a great investor tool for analyzing figures and trends, and reading highlights of the very lengthy full release

Weaknesses of the GDP:

• The data is not very timely—it is only released quarterly
• Revisions can change historical figures significantly