Economic indicators are imperative to gauge where the economy is heading and this can help us make investment decisions. In the last blog, we looked at the following economic indicators –
- Employment Situation Report
- Consumer Prices
It is important to note that movements in the stock market are not solely dependent on these three indicators. Innumerable indicators or combinations of indicators may elicit movements. One must delve deep into the world of economic indicators as only a few a sensitive to the stock market. In this blog, we will explore the following indicators –
- Consumer Spending and Confidence
- GDP
Consumer Spending and Confidence –
Consumers control the economy and it is important to understand spending patterns, incomes and confidence in order to gauge the level of economic activity. Personal Income refers to income left after taking out taxes. Disposable income refers to the final income left after taking out personal tax and non-tax payments. Consumers either spend their income or save. Households tend to save most of the income earned. Their spending is essentially spread across –
- Durable goods – These are expensive products that last three or more years. Examples include cars and washing machines. Since they are expensive, consumers tend to spend less on such goods.
- Non-durable goods – These are goods that last less than three years. Examples include food and clothing. They make up almost 30% of consumer spending.
- Services – Services include healthcare, haircuts etc. and make up almost 60 % of consumer spending.
Consumer spending may increase if consumers see the value of their financial investments increasing. An increase in saving signifies a decrease in consumer confidence. This is because households might be nervous about their financial security. Households might spend more than they earn. This can be troublesome in the long run as debt may pile up or savings may deplete. In order to achieve sustainable economic growth, sharp and abrupt changes in consumer spending and saving should be avoided. Increasing spending will trigger economic activity and positively impact the stock market. However, consumption is increasing even when the economy is operating at its maximum capacity may be a danger sign.
GDP (Gross Domestic Product) –
GDP refers to a value that is placed on the total number of goods and services made in a country. In general, it refers to goods and services that were sold in a country or exported (in a specific period of time). However, regardless of whether the goods/services were sold or not, they are included when calculating the GDP. Therefore, GDP is the final value of the output of a country (or an economy). It is crucial to differentiate between nominal GDP and real GDP in order to track the development of the economy. Nominal GDP refers to goods and services being produced in a country at present prices. Suppose a paper manufacturer in India claims that it made 1000 crore by selling paper this year, 10% more than last year. The question in bold is – Did the company actually produce 10% more paper or did it just raise prices? The answer to this question is the key to understanding economic growth. There should be real increases in output – as it signifies a growing and healthy economy. Simply raising prices would lead to inflation and this would prove to be deleterious as masses would pay more for the same amount of products (their purchasing power would fall).
The Addendum or Final Sales of Domestic Products is a vital constituent of GDP that investors must monitor closely. It has the ability to accurately predict turning points in the economy. It excludes inventory and focus on how much the Government, businesses and consumers are actually spending. If the FSDP is consistently below the GDP , this means that firms are producing more than what consumers are buying. This will eventually lead to pilling up of inventories and cause an economic recession.
An economy growing at a healthy rate will prove to be beneficial for the stock market. However, one should get nervous when the economy is growing too quickly (as this may lead to inflation) or too slowly.
GDP Vs. Dow Jones Industrial Average (DJIA) –
*The information provided by Finance Voyager is for information purposes only and is not intended for advice. Finance Voyager also does not make any recommendation or endorsement as to any investment, advisor or other service or product. The information is only for educational purposes and not buy or sell recommendations.