Why does anyone think gross domestic product (GDP) matters when it comes to future stock market returns, when it’s more often stock market returns that matter for GDP?
We got word this morning that U.S. fourth-quarter GDP was revised up to 3.4%. Why does this matter? Candidly, it doesn’t. Not only should the word “revised” give you pause, but so too should looking to the left of the equal sign to see what’s driving GDP.
First, what is GDP? It’s a comprehensive measure of a nation’s overall economic activity and is a central indicator of economic health. It represents the total monetary value of all goods and services produced over a specific period within a country’s borders. Calculated quarterly or annually, GDP aggregates the output of multiple economic sectors, including personal consumption, business investment, government spending, and net exports (exports minus imports).
And it’s revised a lot.
So, it’s a report card on what already happened that isn’t accurate at moment of initial release. GDP falls short in portraying the overall standard of living or well-being within a country. If GDP is being driven by, for example, the wealth effect that comes from a rising market-cap weighted index like the S&P 500 as small-cap companies still struggle, is it really a measure of how strong the economy is? Or rather how one-sided and uneven things are?
Why GDP Doesn’t Really Matter
Here’s the reality. While there is a positive correlation between GDP growth and share prices in the very long term, the relationship isn’t as straightforward as it seems.
The stock market itself can influence GDP through its role as a sentiment indicator. During a bull market, increased wealth and confidence can lead to heightened consumer spending and investment, boosting GDP. Conversely, a bear market can dampen spending and investment, negatively impacting GDP.
The stock market is inherently forward-looking, often reacting to anticipated future economic conditions rather than current ones. This anticipatory nature means the stock market can rebound during a recession or underperform during periods of economic prosperity as investors price in future risks and opportunities.
But even this is nuanced. One of the reasons for the fourth-quarter GDP revision is consumer spending being higher than initial reports. On the surface, looking at the S&P 500, you’d think consumer spending should be incredibly robust. GDP is reflecting what “the stock market” has been saying throughout 2023.
Yet, as I have continuously stressed, small-cap stocks and retail stocks really haven’t done well. If part of the upward revision on GDP is due to “the stock market” helping to boost consumer confidence, then why is it that the SPDR S&P Retail ETF (NYSEARCA:XRT) is still far from the 2021 peak?
I’ve written about retail stocks on InvestorPlace recently as a bullish part of the market. Momentum is only now starting to pick up. GDP revisions for the fourth quarter reflected retail stocks largely going sideways for the bulk of 2023. I think this can continue, but the point I’m emphasizing here is that anyone who uses GDP as a signal for stocks pushing higher should be careful.
The Bottom Line
If GDP is being driven by parts of the economy that the stock market itself is not rewarding, then you should take these revisions with a grain of salt. It’s better to look at the market itself as a tell. To that end, maybe retailers are starting to sense acceleration in consumer spending, and perhaps inflation. And if that’s the case, GDP isn’t what matters, but rather the inflationary effect of more spending, and what the Federal Reserve does next.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
