Gross Domestic Product, or GDP, is an economic measure representing the total value of all goods and services that a country or region produces in a specific time period, usually a quarter or a year.
The GDP of the United States was $26.49 trillion at the end of Q1, 2023, an increase of 1.3% over the previous quarter, according to the Department of Commerce’s Bureau of Economic Analysis (BEA).
GDP can serve as a quick, numeric shorthand for explaining a country’s economy’s trajectory, and investors can use it as a factor, along with market trends and other analysis, in making their investing decisions. It’s important for investors to know more than just the definition of GDP in order to have context about what the number truly means.
Calculating GDP
When calculating the GDP of a country, economists look at a wide range of factors, including: Public and private consumption, government spending, investments, growth in private inventories, construction spending, as well as the balance of foreign trade (exports minus imports).
The GDP formula can be complicated, so to enable comparisons, countries typically follow a set of internationally accepted guidelines, known as the 1993 System of National Accounts, created by the International Monetary Fund, the European Commission, the Organization for Economic Cooperation and Development, the United Nations, and the World Bank.
In the United States, the BEA uses data collected by other federal agencies, including the Census Bureau, the Bureau of Labor Statistics, and the Treasury. It also gathers information directly from private industry, including trade groups and companies that specialize in sales data for a wide range of products, from prescription drugs to cars.
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Multiple Measures of GDP
There are several ways to measure GDP.
Real GDP
Real GDP is an inflation-adjusted measure of the value of the amount of goods and services produced by a given economy. This is the number typically released by the United States.
Nominal GDP
Nominal GDP uses current market prices to compare countries’ GDP. It does not adjust values based on inflation. If a country’s output remains steady, but the value of what they produce changes, then its nominal GDP would change. That makes it much harder to compare GDP in two different time periods.
Purchasing Power Parity GDP
Purchasing Power Parity (PPP) measures GDP as adjusted for the differences in both local prices and local living costs. This metric allows economists to make more meaningful correlations from country to country about the impact of GDP on the people who live there.
Per Capita GDP
This breaks down the GDP by the number of people in a country’s population. As such, it shows the average output or income of each person in that country, and is often used to paint a picture of the relative wealth or poverty in a given country.
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What GDP Means for Investors
When the GDP makes the financial news, the number in the headline is usually a percentage, namely how much the GDP rose or fell in the most recent quarter. The standard definition of a recession is two quarters of consecutive declines in the GDP.
During a period of rising GDP, employment tends to increase because companies staff up for expansion. This means that more people have more income to spend. That creates more business, which keeps the growth cycle spinning. But when GDP is in decline, the opposite tends to occur, with fewer people working, and wages depressed, leading to a downward cycle.
While there is not a direct cause-effect relationship between the GDP and stock or bond prices, some investors use a strategy known as business-cycle investing to determine how to allocate their portfolio.
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Equity Investors
Many stock investors prefer an economy where the GDP is steadily rising, since it often means a healthy economy and higher company earnings, which can boost the stock market. In contrast, a falling or stagnant GDP can be bad news for stock prices.
Bond Investors
Fixed-income investors may have a different view of GDP. That’s because GDP growth often comes with more borrowing by both consumers and businesses, which can create inflation. Inflation often leads to higher interest rates, which have the effect of driving down bond prices. With sinking GDP, the opposite tends to happen, resulting in higher bond prices.
The Takeaway
GDP is essentially an economic scorecard for a country. By understanding how a country’s GDP is changing over time, and how it compares to other countries, you can get a sense of its overall economic health. Investors can consider GDP trends when planning their investing strategy.
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