Why should average investors care about the GDP?

Gross domestic product

In late October, the Bureau of Economic Analysis (BEA) released gross domestic product, or GDP, numbers for the third quarter of 2017. Analysts expected a 2.5 percent GDP rise, but the first reading of the GDP came in better than expected at a 3.0 percent increase. Overall GDP was $17,156.9 billion. News and financial media outlets commonly correlate GDP with how the economy is performing, but some investors might not know exactly what GDP is, what GDP represents, and why they should care.

To start, you might ask yourself, what does gross domestic product even mean? In basic terms, GDP is a measure of an economy’s total production of goods and services. Therefore, as GDP increases, it means that a country’s economy is expanding, or in simpler terms, improving. Now that we have the definition down, the next step is to go over the different components. Think of GDP as an equation with four different components: GDP = Consumption + Private Investment + Government + Net Exports (imports minus exports). Net exports refer to the trading that the U.S. does with other countries. Imports are goods or services that we receive or buy from other economies, while exports are goods or services that we supply or sell to other economies. The next section will go into further detail on what each of these four components represent.

The first component is consumption, also known as Personal Consumption Expenditures (PCE). The BEA further breaks down consumer spending into two different categories of goods and services. In the U.S. GDP third quarter reading, consumption equated to just under 70 percent of the U.S. GDP. The second component, private investment, accounted for just over 17 percent of U.S. GDP. Private investment is purchases made by businesses that contribute physical goods to our economy, as well as money spent on inventory for goods they anticipate to sell. In this GDP reading, there was a sizable increase in inventories, which could be positive for the economy as companies are stocking up on inventory in anticipation of strong sales. The third component is government, which reflects the government’s consumption and investments. Government accounted for just under 17 percent of GDP this quarter. Lastly, net exports of goods and services were negative, coming in at about -3.5 percent of GDP. As explained earlier, net exports are imports minus exports. Imports impact GDP negatively and exports impact GDP positively. If the U.S. imports more goods and services than it exports, we are considered to have a trade deficit. Since we do have a trade deficit, our net exports are negative for this quarter.

This article is more complex than most of my previous articles, but there are a few things I will sum up as a takeaway. U.S. GDP is a measure of how the economy is doing. A GDP increase signifies that the economy is performing well. On the other hand, if GDP decreases, we could be looking at an economic recession or a shrinking economy. GDP is impacted by various factors, such as consumer spending, business and government spending and investing, and the importation and exportation of goods and services to and from other economies. All of these components make up our economy, which is why GDP is an important metric for most investors trying to make money in the U.S. market.