Is The Economy Healthy – How Experts Read an Economy

Gross Domestic Product (GDP) is the dollar value of all goods and services produced by a country measured over a time period, usually quarterly and yearly.  When compared to the previous year’s GDP, you can gain a quick snapshot of how an economy is doing, the higher the number the more the economy is growing.  That said, an explosive GDP can cause hyperinflation, so there is a balance.

This metric is also used to determine if an economy is in recession, which is considered to be two negative quarters[i].  In Australia economists like to see a GDP growth of at least 2% to account for the growing population.

Consumer spending accounts for around 2/3 of GDP, and a small change in spending habits can have a significant impact GDP.  When there is a drop in the stock market, people perceive they are less wealthy, and spending slows.  This impacts the GDP, which in turn puts more pressure on the value of the stock market.  And so it goes on.  This phenomenon is known as ‘The Wealth Effect’.

You can see that the GDP can have significant impact on investor sentiment.  Investors are generally prepared to pay more for stocks when the GDP is rising, as they see the economy is improving, but if GDP is in decline there will be a perception stocks are worth less.