GDP growth and investments - what you should know

Having an understanding of gross domestic product (GDP) is perhaps vital for investors, as it can influence how investment markets react.

GDP is the total value of goods and services produced in a country. It can be considered as a measure of the health of that country`s economy. When GDP increases, the economy is generally viewed as to be performing well. In turn, the number of people in work normally increases, which increases the amount of money spent in the economy. A virtuous circle, if you like. Usually, a GDP, which is growing well, also translates into enhanced corporate profitability and hence, is good for stock markets.

The reverse, when the GDP shrinks, results in businesses being forced to cut back on production and employment numbers, is self-evidently, not seen as a good thing.

Does GDP movement = good investment decisions?

As such, it wouldn`t seem to be unreasonable that, by following movements in GDP, an investor can make appropriate investment decisions.

However, it is not that straightforward and is far from always being the case. Whilst GDP growth can have a positive impact on equity markets, investors shouldn`t behave as if the two move in step and in line with one another, all the time. While there is some connection, this isn`t always that strong, particularly over the shorter term. One of the reasons for this is because GDP growth shows what the economy did in the (admittedly, relatively recent) past. Additionally, revisions are sometimes made to previously published growth announcements.

Look at prospective GDP growth

By contrast, investing is very much a case of looking to the future, where investors look at prospective GDP growth. They then judge how this could affect their individual holdings. So investors aren`t buying into the GDP growth of a country as such, rather what its impact might have on their holdings.

In addition to the impact GDP growth might have, the value of individual investments is driven by other factors, including supply and demand for that stock, the earnings of the business, dividends and share buybacks, mergers and acquisitions, products, the quality of the management as well as many others.

In recent times, the unprecedented action undertaken by central banks in the form of keeping short term interest rates at record low levels and what is called quantative easing, which has kept longer term interest rates also at record lows, has had its effect too. These actions were intended to make fixed interest investments less attractive by lowering yields and result in investors moving into riskier investments, such as equities. Thereby driving up equity values.

In summary, GDP is significant when assessing a country`s economic health and does influence the direction of financial markets. However, there are many other factors which determine the value of an individual investment and many do so far more significantly and directly, than changes in the GDP of any one country.

Although every effort has been made to ensure that the information provided in this article is accurate and correct, the information provided does not constitute any form of financial advice. We recommend that you take financial advice before making any financial decisions.