Lesson 63 – Trading the News: The Components of GDP

Topic Progress:

In the previous lesson we started a new series on market movements caused by economic releases with a look at the headline Gross Domestic Product number. In this lesson we are going to dig further into the GDP figure with a look at the components which make up the number and why these are important to traders.

In addition to looking at the growth or lack thereof in the overall GDP number, traders will also look at the growth or lack there of in the different components that make up the number. As GDP represents the value of everything in an Economy you can imagine the amount of data that goes into compiling the number, much of which is published for market participants to view. By looking at the different pieces which make up GDP we can get a good picture of what is happening not only with the overall economy but with all the different components of the economy which are reported on to come up with the final number.

Now we could spend many lessons going over all the data that is in this report. The goal here however is to build a framework for understanding the major components so we as traders can understand what is going on when the market reacts to certain pieces of the report and will recognize when to dig deeper for more information on what is happening in a certain sector. The broad categories that it is important to have an understanding of are:

  1. Personal Consumption Expenditures – as over 65% of the US economy is made up of this category, what the individual consumer is doing ie the growth or lack thereof in their consumption, as well as on what goods and services they are spending their money on is heavily focused on.
  1. Private Investment – This includes purchases of things such as computers, equipment and inventories (known as fixed assets) by businesses, purchases of homes by individuals, and of businesses investing in inventories of goods to sell. These are all obviously important things, as how much businesses are investing is a good indication of how they feel about future growth prospects, and how much growth the housing market is experiencing is also an important component of the economy.
  1. Government Spending – this includes pretty much everything the government spends money on besides social programs.
  1. Exports – Imports – an important number which shows how wide the gap is between how much the country exports and how much it imports.

What the GDP number is going to give you a feel for is how much each of the above grew for the quarter and what their overall contribution to the economy was. The above numbers will then be broken down into more detailed numbers which go into compiling the final number for the above 4 categories.

As I discussed at the beginning of the lesson you can dig much much deeper into these numbers to get a feel for what is happening all over the economy. Now that you understand these broad categories however you should be better equipped to quickly gain an understanding of why the market is focusing on a particular piece of data which was released in the report.

You will also find after following these numbers that the market will turn its focus to different parts of the report depending on what is happening with the economy.

That concludes this lesson. In the following lesson we will look at several more economic numbers that lead the GDP number and help market participants predict how much growth the economy is experiencing before GDP is released.