Lesson 62 – What Gross Domestic Product (GDP) Means to Traders

Topic Progress:

As we have learned in previous lessons there are many components of the US Economy which can affect overall economic growth and inflation expectations. Some of the major examples here are how many people are employed in the economy vs. unemployed, how much the housing market is growing in different parts of the country, and at what rate the prices for different products in the economy are seeing increases.

As all of these things are so important to the economy and therefore to the markets, there are no shortage of economic reports which are released to try and help people gauge how things are going with different pieces of the economy. It is important for us as traders to understand the major reports here as even if we are trading off of technicals, understanding what is happening in the market from a fundamental standpoint can help establish a longer term bias for trading. In the short term an understanding of these numbers will also help to assess the erratic and sometimes extreme movements which can occur after economic releases.

The granddaddy of all economic reports is the release of the Gross Domestic Product (GDP) number for the economy. The Gross Domestic Product for the US or any other country is the final value of all the goods and services produced in that economy. Essentially what you get after calculating GDP by adding up the value of all goods and services produced in the economy is a measure of the size of the overall economy. It is for this reason that market participants will watch the GDP number closely as the rate of growth in this number represents the rate of growth in the overall economy.

As a side note here, GDP also allows a comparison to be made of the sizes of different economies from around the world, as well as their growth rates. To give you an idea of just how large the US Economy is, 2007 GDP for the United States was estimated at 13.7 Trillion dollars. This is in comparison to the next largest economy in the world, Japan which has a GDP of under 5 Trillion Dollars.

Quarterly estimates of GDP are released each month with Advance Estimates which are incomplete and subject to further revision being released near the end of the first month after the end of the quarter being reported. In the second month after the end of the quarter being reported preliminary numbers (which basically means more accurate than advanced) normally are released and then finally the final GDP number is released at the end of the 3rd month after the end of the quarter being reported on.

Traders are going to focus heavily on the growth rate released in the Advanced number and markets will also move on any significant revisions made in the preliminary and final GDP numbers.

While a high rate of growth in this number represents a fast growing economy, remember from previous lessons that this can be a good or a bad thing for the markets as they anticipate and react to future growth prospects. If high growth comes without an increase in inflation expectations then market participants will normally remain optimistic about future growth and we should see market rallies as a result of this. If however a high growth rate is considered unsustainable without excessive inflation, market participants may react negatively to this as they anticipate monetary policy action to slow the economy down in order to contain inflation. Once you begin to follow the analysis which differing sources such as the Wall Street Journal and Bloomberg.com put out on the release you should have a good feel for what the market is expecting from the number and how the market should react if
the number comes in out of line with expectations.

As a general rule of thumb most people feel that the maximum the economy can grow over the long term without running into inflation problems is around 3%. While the quarterly numbers can deviate up and down from this fairly significantly, it begins to cause inflationary concerns when growth stays or is anticipated to stay much higher than that for long periods of time.

There is obviously a huge amount of data that is used to compile the GDP number and much of this data is made available with the release. As much of this data gives traders a window into the health of all the different areas of the economy heavy attention will also be paid to the various components of GDP. This will be the topic of the next lesson.