Why is the GDP Report Important to Stock Investing? – Economic Indicators Pt.1
Have you ever heard an investor or analyst say “Look at the Macro”before?
What they refers to is the Macroeconomics of the United States. It is extremely crucial for an investor to know such indicators because it puts into perspective the current and future health of our economy. If you are investing in stocks this tools can help you predict future movements in sectors and hopefully help you create a better investment strategy.
There is no coincidence that the release of this important documents have such an impact in the stock market.
In this series of post we will analyze the major Economic Indicators that will help you make important investment decisions in the future.
Check our post How the Economy Works (Video) to get a better idea on how the economy affects our every day lives.
GDP (Gross Domestic Product)
The GDP is probably the most important indicator out there. The report measures America’s economical health, GDP also measures the speed in which the economy is growing. Before digging in into possible investment strategies that we can attain by using this report is important we understand all the aspects of the GDP.
Release Time: 8:30am Quarterly (Jan, Apr, July, Oct). Two rounds of revisions follow, each a month apart.
Official Release Website: https://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
Free iTunes App For Economic Indicators: America’s Economy App
The Gov’t computes the size of the economy in two ways. One is nominal-dollar terms and the other is real-dollar term.
Current (or nominal-dollar) GDP accounts the value of ALL goods and services produced in the U.S. using present prices.
On the other hand, Real (or chained-dollar) GDP counts only the value of what was physically produced.
There are 4 Major Components in the GDP report:
- PCE (Personal Consumption Expenditures)
- Gross Private Domestic Investment
- Net Exports
- Government Consumption Expenditures and Gross Investment
1. PCE (Personal Consumption Expenditures)
In this first section of the GDP we are going to find where the U.S. has sold the most durable and non-durable goods for the quarter. Take in mind that the numbers are usually in billions of dollars.
Personal Consumption accounts for more than 70% of our GDP, giving it a huge weight in our production.
it is divided into Durable goods, nondurable goods, and services
This are big-ticket items such as refrigerators, TV’s, autos)
This are vegetables, sweaters, and shoes. “During uncertain economic times, households might postpone the purchase of a new car or large plasma-screen TV, but spending on food and fuel oil cannot be delayed”
“That is why investors rush to buy shares of companies that produce nondurable goods when the economy is weakening and sell shares of durable goods”.
Account for services such as medical and dental care, haircuts, transportation, legal costs etc..
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Why is it important to stock investing?
If we observe that U.S. companies are not producing at their usual rate, we can assume that there is something bad with the economy.
Consumption creates demand, thus stimulating business activity. In other words, if people are not spending their money in the sector observed it could mean that companies in that sector will probably report weak sales at the end of the quarter.
GDP report usually comes in before companies report their earnings for some companies.
Some Stock Investing Strategies to consider:
You have to keep in mind that everybody interprets the GDP differently, there is no secret formula to making millions in the stock market.
This same type of analysis is going to be applied to all the different components in the GDP.
For example if we observe that the sub-section under PCE “Motorcycle and Vehicle Parts” has been decreasing for a couple of quarters, you may want to sell your stocks in Ford, O’Reilly, and any other stock related to this market, as they may report weak earnings. The same applies if you see the sector growing, it is important to see the big picture and all the possible companies that may be affected.
For example housing affects Furniture Wholesale companies, Tool Wholesalers (like Home Depot, Lowes), House Paint, Construction Equipment, Landscaping Companies, etc.. You get the picture?
2. Gross private domestic investment
This component constitutes for about 15% of our national GDP
It is broken down into two sub-sections:
- Fixed investment
- Change in inventory investment.
Nonresidential expenditures (office buildings, warehouses, computer equipment, etc).
Buildings “It makes no difference whether these homes are occupied; all that matters is that they were built”.
If companies are building more houses usually means that people are confident with their finances.
During 2008 this was one of the components that was affected the most.
3. Net exports
This GDP component accounts for about 13% of GDP
The term Net Exports is simply the difference between adding exports to the GDP accounts and subtracting imports.
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4. Government consumption expenditures and gross investment
If you are interested in knowing how much the government spends check out this component. It can also show us possible investment opportunities in cement for example if more highways are being built, get the picture?
It represent 18% of GDP (21% in the mid-80’s)
highways, NASA, Parks, salaries of non defense federal employees.
Other Notes on GDP
- Final sales of domestic product and gross domestic purchases both of which are listed in the GDP table under “Addenda”
- Many people argue between the CPI and PCE price index to calculate the effects of inflation and determine monetary policy.
- The PCE price index is sensitive to ongoing changes in consumer spending patters due to its flexibility in pricing compared to the stagnant prices of the CPI which can remain like that for years.
- 3% growth in GDP is the minimum required to lower unemployment.
- One early warning sign that the economy is about to switch tracks comes from Real final sales, not GDP. The final sales figure is a purer measure of demand in the economy. It excludes inventories and looks at how much consumers, businesses, and government are actually spending.
- If the rise in final sales slip below GDP growth for an extended period of time, it means companies have been producing much more than what people are interested in buying. As a result companies will halt in production.
- Historically, S&P 500 earnings growth tended to stay in line with nominal GDP. While profits may surge from time to time, over the long run they cannot increase faster than economic growth.
- GNP (Gross National Product) calculates goods produced by U.S. citizens regardless of their geographic location, GDP accounts only for those produced in U.S. borders.
Impact on The Bond Market
Question to ask: How the GDP data compares with expectations? If the economy is growing at or below the pace protected by economists, the bond markets is likely to react positively, especially if real final sales are anemic and unwanted inventory are ballooning.
Impact on The Stock Market
Question to ask: How the latest release affects the outlook for corporate profits?
If economic activity has been racing ahead of 3.5% rate for several quarters, even shareholders start to get nervous about rising prices.
Higher inflation will cause an erosion in household purchasing power and probably will force interest rates higher.
Tell me what you think or if you would like to see more posts like this in a comment below!