Upbeat music plays throughout.
Narrator:
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 essentially the value if you were to add up 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.
On-screen chart: Hypothetical chart comparing Germany GDP to DAX (German Stock Index). GDP shows a large dip but is generally moving up over time, and DAX shows similar overall upward trend.
Narrator:
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 pickup truck or your daily 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: these are things companies spend money on. Think real estate and equipment... Home building and intellectual property…. If a coffee shop buys more efficient coffee grinders or an automaker builds a new plant.
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.
Siren blares
Narrator:
No, no, that's ok. It's totally normal. A lot of countries import more than they export. In 2023, the Unites States imported $773 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.
U.S. GDP was $22.7 trillion in 2023. That's a huge number. Like, way 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. The bars vary, right? " GDP grew by 2.1 percent last quarter" is much easier to understand than “GDP was 22.7 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.
So, now we know what makes up GDP. How does any of that actually matter to your portfolio? Well, on a macro level, significant and unexpected changes in an economy can upend its equity 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 look back at how everything fared over previous quarters.
Think back to the beginning 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%.
On-screen chart: Line chart showing S&P 500® level percent change from February 3rd through March 30th 2020. The chart drops about 30% between February 3rd and March 23rd before regaining 10%. Source: YCharts®
Narrator:
While GDP was down a little that quarter, it wasn't until Q2 that it really 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.
On-screen chart: Bar chart showing real GDP percent change from previous quarter, quarters 1-4 of 2020. Q1 shows a small drop, Q2 shows a drop approaching 35%, Q3 shows a rebound approaching 35%, and Q4 shows a slight gain. Seasonlly adjusted annual rates. Source: U.S. Bureau of Economic Analysis
Narrator:
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, but take the cycle with a grain of salt. Recent cycles have been a little less predictable than they may have been a few decades ago.
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.
On-screen chart: Line chart showing China GDP year-over-year percent change mid-2013 through 2024. Line hovers around 7% before dropping to 2% in 2020, rebounding to over 8% in 2021, falling to 3% in 2022, and rebounding to 5% in 2023 and 2024.. Source: thinkorswim®
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, but think of it this way: It's not about whether it's good or bad news when it comes to GDP that moves markets; it's when GDP moves unexpectedly.
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