Monday, February 8, 2010

How To Read GDP Reports

How To Read GDP Reports
A country’s Gross Domestic Product, or GDP, is one of the most accepted and widely recognized metrics for gauging the level of activity in an economy. Yet there are many pitfalls in analyzing GDP to provide quality insights for investment strategy, market timing, and understanding broader economic themes that are playing out.

This article serves as a primer for those with limited-to-medium knowledge about using GDP metrics, and takes a markets and investment perspective. It’s also intended to act as a bit of a thought starter and I welcome those with extra hints and tips to post them on Seeking Alpha, or the Econ Grapher blog.

GDP Values and Percentages
There’s a range of different values you can look at e.g. PPP adjusted, nominal, real, local currency, and then there’s production versus consumption methods of calculation. The main thing you need to know is that most countries release GDP on a quarterly basis and generally in value terms, but sometimes in the form of indexes.

One of the best ways of using this data is by taking quarterly percent change e.g. Q2 divided by Q1. This shows the rate of economic growth through the year and is best examined in a series e.g. the last 5 years. Once examined over a series you can detect trends, and see booms and busts. It is also worth taking an annual percent change e.g. Q2 2009 divided by Q2 2008. This measure tends to be less choppy and gives you a better gauge as to where the economy is now versus a year ago.

On percent changes, the US tends to report GDP results using a peculiar method called “annualizing”; this is a misleading and not particularly helpful way of measuring GDP growth. To convert the number back to simple quarterly percent change you can divide it by four.

The point of looking at growth in GDP is that it flows through into things like earnings growth, disposable income, interest rates, etc. For example if economic growth is consistently high, you would expect that on average companies’ earnings will be growing. On interest rates, it’s a little more complex, but a strong economy will tend to lead to higher interest rates as more companies borrow to fund expansion (borrowing means an increase in the supply of debt – so if demand for debt is constant then the price will fall; which means an increase in the interest rate).

So at this point we’ve established that % changes in GDP are important for figuring out whether the economy is growing or not, and therefore what will in turn happen to investment markets. The next step is to look at three important terms for GDP growth rate releases.

Estimates, Preliminaries, and Revisions
There are three things you need to know here. First one is about estimates; many news outfits like Bloomberg, Reuters, Econoday will poll economists and strategist to obtain their estimate of what the GDP figure will be. These “consensus estimates” will tell you what the market is broadly expecting. It also sets the scene for how the market will react e.g. if forecasts are for 5% growth and the result comes in at 1% then it is a disappointment and the market will probably sell-off.

There is a caveat to this though, and that is to look closely at the components (next section) because sometimes the market will react more to the hidden messages in the report.

The next distinction to make is between preliminary and final results – it’s fairly simple; most countries give a first estimate as a means of providing a timely indication of economic activity. Naturally revisions follow as more information becomes available and assumptions are updated. These revisions can also move the markets if significant.

Components: GDP = C + I + G + (X – M)
The next thing to look at is the components. This is critical for drilling into what exactly is driving economic growth and assessing the make up of an economy. Quickly, the components are basically: C=Consumption, I=Investment, G=Government, X=Exports, M=Imports (sometimes the trade balance is simply referred to as “net exports”).

You can approach this from a few angles e.g. what proportion of GDP is accounted for by consumption expenditure (e.g. US is about 70%). This is useful for assessing the make up of an economy and therefore where it’s key strengths and weaknesses are.

Another important angle to look at is how each individual component is changing both on the quarter-by-quarter basis, and annual percent change basis. By looking at it this way you can tell where the growth is coming from e.g. in the recent US GDP report the bulk of the growth came from growth in investment, and net exports. In most GDP reports you can drill further into subcategories e.g. investment can be split into real estate versus business investment etc.

The value of investigating the individual components of GDP results is developing a better understanding of the economy. With this better understanding you can better position yourself to figure out what might come next…

Past, Present, and Future
As an investor or someone with a vested interest in the level of economic activity (generally everyone who exists in that economy!), you’re generally more concerned about the third: the future. The past is useful for understanding previous relationships and trends, the present is useful for understanding the current make up and position of the economy, the future is largely unknown and of critical importance in making quality decisions.

So it’s important to probe into components to see if trends are building e.g. imbalances like over-reliance on consumption, or large growth in investment that might herald stronger future growth, or excessive contributions of government that will likely reverse at some point. This is the part where more in-depth analysis of GDP results can really add value to investment decisions and market timing.

Finding the Data
Now that you know a bit more about analysing GDP data it’s worth outlining some of the source of the data. Another important angle to look at is how one economy compares with another e.g. a common comparison is emerging market economic growth versus developed economies. To this end it’s useful to consult databases that store commonly measured data. For this you can visit the websites of the OECD, IMF, World Bank, as well as data aggregators like Trading Economics.

The other option is to go straight to the source; this tends to be the national statistics office of the country in concern. A quick google search will often get you there, but to get you started here’s a few examples:
-US Bureau of Economic Analysis,
-China National Bureau of Statistics,
-EU Eurostat,
-UK National Statistics Office,
-Australia Australian Bureau of Statistics,
-New Zealand Statistics New Zealand.

Then of course there’s the countless articles and analyses in the media and on blogs like Seeking Alpha. There’s also economic and investment research reports from investment banks and asset management firms. Econ Grapher recently published an article that looked at GDP results from the US, UK, and South Korea (here), which you can check out for an example.

Summary
GDP reports often contain useful information about an economy, and provide important basis for solid analysis that can support investment decisions and other decisions that depend on outcomes that are determined by the state and course of an economy. Through paying attention to the details and knowing how to make good comparisons and asking the right questions you can arm yourself with knowledge and insights to make good decisions.

Article Source: http://econgrapher.site1.net.nz/howtoreadgdp.html

4 comments:

  1. It's also worth checking out the Econ Grapher graph library as there's quite a few GDP charts in there for you to use...

    ReplyDelete
  2. Thanks Econ Grapher - will put you on my blog in the References section (http://crisismaven.wordpress.com/references/) plus under featured sites: Here's my take on the GDP: How GDP betrays the Economy (http://crisismaven.wordpress.com/2010/01/25/how-gdp-betrays-the-economy/).

    ReplyDelete
  3. Thanks for the comment chrisismaven, I will check it out.

    ReplyDelete
  4. Blogs are so informative where we get lots of information on any topic. Nice job keep it up!!
    _____________________________

    Resume Writing Help

    ReplyDelete

What do you think?