Understanding GDP

by Jason Jenkins, Investment U Research
Wednesday, February 22, 2012

Gross domestic product (GDP) is the mother of all economic indicators.

And it’s commonly used as a gauge of the economic health of a country, as well as a country’s standard of living.

It also serves as a measure of a nation’s productivity and 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).

The Bureau of Economic Analysis (BEA) is an agency in the United States Department of Commerce that provides this info every quarter, first in an advance release four weeks after quarter ends, then in a final release three months after the quarter ends.

What it Means for Investors…

Real GDP (inflation-adjusted GDP) is the key factor that says the most about the well being of the economy. The BEA’s advance release is always heavily anticipated and has the ability move markets.

It’s by far the most followed, discussed and digested economic indicator out there – useful for economists, analysts, investors and policy makers. The popular rule of thumb states that somewhere in the neighborhood of 2.5% to 3.5% per year growth in real GDP numbers is a healthy economy. This range will provide for corporate profit and jobs growth just enough so that inflation won’t rear its ugly head.

The “corporate profits” and “inventory” data in the GDP report are a great resource for those investors putting money into equities. Both categories show total growth during the previous quarter; corporate profits data also displays pre-tax profits, operating cash flows and breakdowns for all major sectors of the economy.

The BEA even supplies its own analysis of the quarterly data, presenting several useful documents that condense the massive release down to a manageable and readable size. They also provide an annual analysis of data that segments results down to the industry level – a very useful tool for both equity and fixed-income investors who are interested in particular industries related to their holdings.

The Most Recent Report

On January 27, 2012, the BEA released the advance estimate of real GDP growth for the fourth quarter of 2011. Real GDP grew at a seasonally adjusted annual rate of 2.8%, up from 1.8% in the third quarter. The main contributors were private inventory investment and personal consumption expenditures (PCE). Declines in government spending, at the federal, state and local levels reduced growth.

And markets barely moved the day it was released. Why, because economic numbers can tell you two stories. The 2011 fourth quarter increase of 2.8% came in below expectations, but was a welcome improvement over the third quarter 1.8%. There was the “good” news that inventory stocking contributed 1.94% of the 2.8% GDP growth.

However, it was countered by the fact that part of future economic growth was taken in 4Q2011 – GDP is determined at point of manufacture, and not point of sale.

It’s important to know what the numbers mean in order to provide your own due diligence. Remember, one report over a specific period of time isn’t the best investment indicator – but it can be a piece of the pie.

Good Investing,

Jason Jenkins

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