Gross Domestic Product is a powerful indicator of the health of an economy. We can easily compare this indicator across other countries.
Variations in the Gross Domestic Product of a nation influence in a significant way every financial market.
The rule is the Stock Market in the long run rises. In the last 90 years, he has earned about 10% per year.
This result is impressive when compared to other asset classes. However, this does not mean that in the short term, it cannot have significant collapses.
There have been many financial shocks, the last one in 2007 when the market collapsed for months, and many investors got hurt.
Traders no longer use this approach. However, it is always used as a benchmark to evaluate the validity of a trading strategy.
How Gross Domestic Product influences the Stock Market in the long run?
There is a direct relationship between Gross Domestic Product growth and equity valuations.
The economy does not work in watertight compartments. When the economy is doing well, companies are earning and vice versa.
Also, remember that stock valuations are very much based on analyst expectations. So if the economy is doing well, companies are also expected to make good money.
There are other indicators to watch and will be examined in future posts, but the Gross Domestic Product is the most important.
The economy, however, is going through cycles, the same for financial markets.
Logic would like that when there is a deterioration in the real economy, one should also see a subsequent decline in the financial markets.
This does not always happen, and in recent years, it is happening less and less. Why?
Stock Market VS Central Bank and Government
The increasingly invasive intervention of governments and central banks has meant that all operators expect a central bank intervention with the economy’s worsening.
The central bank intervenes by manipulating interest rates; in this way, it manages to affect the financial markets and the real economy.
The financial markets will react much more violently to increasing or decreasing interest rates than the real economy.
This is because valuations in the financial markets are also based on the expectations of the operators.
The political events can affect the financial markets and create short-term shocks that can turn into long-term trends.
When conditions worsen, there is an exit from the stock markets towards safer and less volatile assets.
However, this trend has diminished in recent years due to the lack of alternatives to equities due to too low interest rates.