GDP Growth and Equity Returns

Recent headlines discuss “disappointing” gains in the U.S. GDP (Gross Domestic Product).  The Gross Domestic Product or GDP is a measure of all of the services and goods produced in a country over a specific period, classically a year.  The GDP had a limited gain in the 2nd quarter 2016 of 1.2%.  Many investors look to gross domestic product (GDP) as an indicator of future equity returns, but should they.  The question they should ask is the following:

Is there a relationship between the two financial items that investors can use?

According to the GDP estimate released by the Commerce Department on July 29, 2016, annualized real US GDP growth was 1.2% in the second quarter of 2016—below the historical average of 3.2%.1  This follows last quarter’s disappointing gain of only 0.8%.  This might prompt some investors to ask whether below-average quarterly GDP growth has implications for their portfolios.

Market participants continually update their expectations about the future, including expectations about the future state of the economy. The current prices of the stocks and bonds held by investors therefore contain up-to-date information about expected GDP growth and a multitude of other considerations that inform aggregate market expectations. Accordingly, only new information that is not already incorporated in market prices should impact stock and bond returns.

From 1948 to 2016, the average quarterly return for the S&P 500 Index was 3%. When quarterly GDP growth was in the lowest quartile of historical observations, the average S&P 500 return in the subsequent quarter was 3.2%, which is similar to the historical average for all quarters. This data suggests there is little evidence that low quarterly GDP growth is associated with short-term stock returns above or below returns in other periods.

Quarterly GDP estimates are released with a one-month lag and are frequently revised at a later point in time. Initial quarterly GDP estimates were revised for 54 of the 56 quarters from 2002 to 2015.2 Thus, the final estimate for last quarter may end up being higher or lower than 0.5%.

Prices already reflect expected GDP growth prior to the official release of quarterly GDP estimates. The unexpected component (positive or negative) of a GDP growth estimate is quickly incorporated into prices when a new estimate is released. A relevant question for investors is whether a period of low quarterly GDP growth has information about short-term stock returns going forward.

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Sources: S&P Dow Jones Indices, Bureau of Economic Analysis.
Past performance is not a guarantee of future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.
  1. Source: Bureau of Economic Analysis.
  2. 2002 to 2015 is the longest time period for which BEA provides data comparing initial to final estimates. The average difference between an initial and final estimate was 1% in absolute magnitude over this time period.
Adapted from “GDP Growth and Equity Returns,” Issue Brief, May 2016. Dimensional Fund Advisors LP is an investment advisor registered with the Securities and Exchange Commission.
All expressions of opinion are subject to change. This information is intended for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services.

About Dan Crimmins

Dan Crimmins, co-founder of Crimmins Wealth Management, is a financial coach and fee only financial planner. Have a financial question? ASK DAN

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