How does GDP affect the stock market?

GDP - Gross Domestic Product

Why is it important?

Gross domestic product (GDP), is the measure of the value of the goods and services produced by the U.S. economy within a given time period.

GDP is one of the most comprehensive and closely watched economic statistics. This is because several government institutions make key decisions concerning the economy using it. The White House and Congress uses the GDP statistics to prepare the Federal budget, the Federal Reserve formulates monetary policy basing on the same. Wall Street and the business community also depend on the GDP to prepare forecasts of economic performance that provide the basis for production, investment, and employment planning.

Due to the procyclic nature of the GDP as an indicator, it is the most obvious statistic to look up to when judging the present status of an economy any where in the world. This statistic is also used to determine the poverty index of an area and will thus influence in a great way the government’s investment strategies towards improving the area.

How is it compiled?

The government collects all information regarding investments and incomes earned by individuals as well as companies from the national income and product accounts (NIPAs) produced by the Bureau of Economic Analysis (BEA). The NIPAs are a set of economic accounts that provide information on the value and composition of output produced in the United States during a particular period and on the distribution and uses of the income generated by the same production.

GDP is composed of goods and services that are produced for sale in the market. It is however worth noting that there are goods that are produced but do not really go into the market directly. These include services such as the defense services provided by the Federal Government. Education services provided by local governments and other emergency housing or health care services provided by nonprofit making organizations such as the Red Cross also fall in the group of non-market productions, Homes or business structures that are owned and occupied by the same persons all have to be taken into consideration when computing these statistics. However, not all productive activity is included in GDP. Some activities, such as the care of one's own children, unpaid voluntary work and illegal or black-market deals are not included because they are difficult to evaluate, as no real documentation is available following such transactions.

GDP’s impact on Forex

GDP simply portrays the way money is earned and spent on a regular basis, it is therefore has a very direct relationship to the foreign exchange rate. When the production is high and it translates into good revenue the currency grows stronger. There are however other factors that may lead to negative trends in the forex market. Take the situation of GDP getting high due to some factors such as illegal dealings such as money laundering or criminal activity such as huge ransoms in the case of piracy in the high seas. The effects would lead to inflation and the dollar may loose its purchasing power, as there would be too much money circulating that has not actually been earned. This would reduce the demand for the dollar and the forex rates would have to come down. If the inflation persists, the federal bank may be compelled to adjust interest rates in order to contain the situation. Such a move automatically affects the forex rates.

There is a likely chance that a high GDP may attract foreign products into the country from other countries. If many countries target the U.S. as their export destination, it is likely that the country may surfer a balance deficit due to too many imports at the expense of local exports. The country may find itself importing more than their exports can match, a situation that may reduce the dollar rate internationally.

How does GDP affect the stock market?

The performance of the stock market is always directly linked to liquidity among the players. It is thus directly linked to the GDP in the sense that a high GDP will mean increased activity at the stock markets and a low GDP will translate into a decrease in activity as many people shy away from the markets due to problems such as liquidity preference. Most investors like to hold onto cash when they are running low on the same. The reactions when the economy is registering a high GDP is the demand for shares going up as many people have some surplus money to put aside. They will always opt to put it into stocks and hold it there speculatively with the hope that it can be useful when the economy takes a down turn and they are in need of cash to bridge the gap.

Introducing new stocks into the market should be done in a tactful manner. For this reason, many companies or smarter investors will tend to offload the shares they have held for some time during low seasons at times when the GDP is high as they are likely to fetch good prices. To make good profits in the stock market, a smart investor should be observant of the GDP performance. He/she should then be smart enough to buy stocks at low prices during periods when the GDP is low and then hold it strategically until the GDP improves and ordinary people start looking for stocks to act as stores of value. They are thus likely to buy them at profitable rates from the smart investor.

A good GDP indicator attracts foreign investors into the economy. This trend will directly result in the improvement of prices of companies that these foreign investors may choose to invest. At that even long term investors are attracted into a market that has a steady and good GDP as these gives them the predictability that they need when making long term investments/. Erratic economies with an equally erratic GDP do not attract any long-term investments from foreigners for fear of the unforeseen eventuality.