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It finally has happened! The financial markets have come back down to earth. Irrational exuberance, unwarranted percentage gains, easy money making or even sure bets are all over. The first quarter of 2000 has been very brutal for all the momentum investors out there. Yes, you can still get great returns and make lots of profit in the stock market, but you must now go about it the old fashioned way. In other words, you must do your homework. Study the fundamentals of the companies, look at their financial statements but also, and maybe more importantly, one must gauge the economy properly. Indeed, the economy’s health is the ultimate indication on the future of stocks. As the economy prospers, the stock market follows and vice versa.
The Gross Domestic Product (GDP) report is without a doubt the most important economic indicator. Used by wall street analysts as well as the federal reserve committee when evaluating the economy, it gives us a clear view of the growth (or slow down) that is taking place in the business world. The GDP is also one of the most thorough economic indicators used to measure the entire economy. Calculated every 3 months, the GDP is usually released on the third week of the first month of each quarter. The Commerce Department on the Bureau of Economic Analysis is in charge of compiling and publishing the numbers.
In order to give us a precise view regarding the evolution of our economy, the GDP assembles the value of what is produced in the US, including all goods and services produced by individuals and businesses. Furthermore, it also takes into account the imported and exported goods that are traded between countries. The number published in the GDP report is usually the annualized economic growth. This number is based on the quarter to quarter GDP increases.
Lately the economy has been growing at an average pace of 5%, well above the 2.5% growth rate that is believed to be the optimal long-term growth rate. Indeed, a growth rate above 3% is usually associated with inflation, and therefore is detrimental to the long-term economic health. Lately however, the impressive increase in productivity has helped in keeping inflation at low rates while taking advantage of the impressive economic growth that the country is undergoing. The federal reserve has however expressed concern about sudden inflation and economic slow down and taken appropriate measure to prevent such side effects of our economic growth. In deed, by raising interest rates, they have managed to slow down consumer spending and therefore keep the inflation under control.
This goes along to show us the importance of the GDP number. As we can see it is an essential gage of the economy and can therefore help us anticipate future changes in interest rates, as well as stock market corrections or rallies. Clearly, one can go much deeper than the published numbers of GDP and analyze the entire state of the economy by dissecting the numbers one by one. For the purpose of this article, however, we have stuck with the basic and most important number.