Hardy Plumbing
April 26, 2006

Money Matters

Stock Market Performance And GDP

In case you may have failed to notice, as of March 30, the Dow has remained above 11,000 for the past 15 days, 31 days in all for the first quarter, according to WSJ numbers. We have not been treated to numbers like this since 2000, when the DJIA hit an all time high of 11,722 on Jan 14, 2000.

Despite wars, pestilence of all types, kidnappings, bombings, rising interest rates and oil prices, steadily declining numbers for the current President's approval ratings — you name it — this economy keeps chugging.

If you find this confusing, take a look at the numbers underlying the economy. Corporate profits jumped 21.3% in 2005 to $1.35 trillion, representing the largest share of national income in 40 years, 11.6%. To stock market investors, rising profits are like rising rents for real estate investors — a nice feeling.

The Bureau of Economic Analysis released its final report on Gross Domestic Product for the fourth quarter of 2005. Real gross domestic product, calculated as the output of goods and services produced by labor and property located in the United States, increased at an annual rate of 1.7% in the fourth quarter 2005. In the third quarter, real GDP increased 4.1% annualized.

Gross domestic product is the universally accepted measure of the economic activity of the nation. It is the sum of final output measured by the equation C+I+G +(X-M) = GDP where C is consumer spending, I is private or business investment, G is government spending, and X-M is the net of exports minus imports.

As the economy goes through different cycles, the changes in the components become important indicators to market watchers. For example, the I component, or business investment, contributed to the 2001 recession by decreasing -7.9% in 2001, and further shrinking by -2.6% in 2002. Yet, the economy remained afloat thanks to the consumer, whose spending increases, year over year, were +2.5% and +2.7% for the same years.

While year over year changes in consumer spending are +2.9% 2003, +3.9% 2004, and +3.5% for 2005, the real muscle for the economy is coming from the change from negative growth in business investment in 2001 and 2002, to strongly positive figures in 2004 and 2005, where year over year changes were +11.9% and +6.1% respectively.

Those worried that the government is spending the economy into a deep hole might find some comfort in the fact that the growth in government spending is decreasing from +2.8% 2003 to +1.8% in 2005.

The above figures came from the BEA's web site, www.bea.gov.

GDP as an indicator has evolved since the 1930s. Simon Kuznets, an economist hired by the U.S. Department of Commerce in the 1930s, led the creation of a national accounting system. Up to that time, policy makers had little idea how the economy was performing, and worse, had no way of predicting with any accuracy, the impact of fiscal and monetary policy changes on the nation's economy.

Today we take for granted the operations of the Federal Reserve Board as it attempts to control the nation's money supply, and indirectly, inflation. With libraries of data at their fingertips, these watchdogs of our money can make relatively informed decisions as opposed to their predecessors in 1928 and 1929 that are widely criticized for their actions which many felt contributed to the crash of the stock market. Little mention is given, however, to the difficulty these Fed governors had who were "flying blind," without any reliable data to guide their decisions and measure results.

Markets will continue to react to changes in GDP. Strong positive growth is good for the stock market, and generally a negative for bonds, as increased economic activity tends to push up prices and interest rates. The opposite is true as the rates of change decline.

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