In this interview, DeAnne Steele, investment executive for the western United States at U.S. Trust, focuses on perhaps the most often-discussed aspect of the economy, gross domestic product (GDP), exploring its various components, how U.S. Trust’s investment professionals incorporate GDP into their analyses of markets and trends, and how GDP and forecasts for GDP are factored into investment decisions.
This year has provided some interesting statistics around growth in the United States with the terrible winter and first-quarter GDP coming in negative. Earlier in the year, these events led many to question whether we were headed into another recession, and to wonder what is really behind GDP.
Can you walk through the components of GDP?
GDP for the United States is the value of all goods and services produced in the United States, which is just under $16 trillion.1 To put it into a basic formula: GDP = G + I + C + net exports. G represents government expenditures and investments and measures approximately 18% of our economy. I represents private, domestic investment, which currently accounts for approximately 16% of our economy. C measures personal consumption and represents approximately two-thirds of our economy. Net exports (exports minus imports) have historically been negative for us as we import more than we export, as we are excellent consumers of goods and services made both here and abroad.
Why was first-quarter GDP negative?
First-quarter GDP was brought down by a number of unusual items, the most significant of which was the terrible winter. One of the coldest winters on record shut down roads and factories, suspended commercial and residential construction, delayed shipments of parts and hurt consumer spending. This affected the ability of companies to replenish inventories, causing inventories to subtract 1.7 percentage points from GDP.
With inventories at such low levels, we are much more likely to build inventories up than further subtract.
The inventory withdrawals and lack of replenishment left inventories at a rate below where they are needed to keep inventory-to-sales ratios steady. Net exports also detracted from GDP, as we exported less. Our ability to export was affected by the weather, as roads were shut down, limiting our ability to get the parts needed to build exportable goods and also our ability to get those goods to port. The U.S. consumer did remain strong, however, as imports rose and personal consumption went up 3.4%.
The good news is that typically 80% or so of lost economic activity during a weather-related event carries over, which is why we have since seen economic activity picking up. Also, with inventories at such low levels, we are much more likely to build inventories up than further subtract from them, which may boost GDP.
Why was the stock market hitting new highs
when the numbers were released?
What the first quarter illustrated is how fragile our economy is given low growth and low inflation. It does not mean, however, that we are headed into a recession, especially in light of the fact that the private sector continues to grow near a 4% nominal rate. Companies are better positioned than ever with record cash on their balance sheets and low rates on their borrowing, and many are on their way to producing record earnings for the year. All these factors, combined with leading indicators suggesting that the growth is picking back up following the harsh winter, explain why the markets hit new highs even as we reported negative growth in GDP.
How should investors factor GDP
into decisions about investing?
GDP is a coincident, or lagging, indicator. It takes months to calculate and many more months after the first release to finalize. Therefore, it only shows us where we have been. Key to forecasting the growth of the economy and in turn growth in earnings is to look forward, as the stock market itself is a leading indicator and discounts future GDP growth.
As such, leading indicators are much more helpful in forecasting stock market returns than GDP. These include measures such as average weekly hours, ISM index of new orders, and consumer expectations — all of which are part of the Leading Economic Index (LEI).
At U.S. Trust, our focus on leading indicators is what gave us the confidence to recommend to clients that they increase equity allocations in their portfolios in March of 2009 within days of the market bottom. That quarter, GDP was –5.4% (see Real Gross Domestic Product chart below). A focus on GDP and not on leading indicators likely would have led investors to avoid the equity markets through at least the fourth quarter of that year when GDP was released for the third quarter and finally showed positive growth.
What is U.S. Trust’s forecast for
the United States and the globe?
We expect continued economic growth and expect the real GDP for the United States to end 2014 between 2.0% and 2.5%. Add inflation of 2% to 2.5% and the nominal GDP could be 5%. Next year, we’re expecting economic growth to continue to accelerate and end 2015 between 3.5% and 4.5%. Inflation should be similar if not a bit on the higher end of that range (2.0%–2.5%)
Global real GDP is expected between 3.0–3.5% this year and 4.0–4.5% next, enhanced by stronger emerging-markets growth, yet still constrained by Europe. We foresee higher but not spectacular growth. But we expect to see growth in the stock markets around the globe. And one benefit of a slow-growth recovery should be a longer recovery.
1"Real" GDP in terms of chained 2009 dollars. Source: Bureau of Economic Analysis, 2014.
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OTHER IMPORTANT INFORMATION
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