The GDP and Me

Every three months there is a flurry of activity in many economics departments when the quarterly GDP data is released. Today was no exception, but I don’t get as fussed.

First, the data is dated: We are now in the last month of the March quarter and this GDP result was for the December quarter. Second, few outside of the boffins know or even care what GDP is. Third, measures such as GDP of the overall health of the economy are not reflected in the overall sharemarket index.

The sectors that make up the ASX sectors have vastly different weights to the corresponding underlying sectors in the economy. The reason is that a lot of economic activity is not listed on the sharemarket and many listed sectors do not reflect their share of economic activity. For example in the ASX:

• Financials are nearly double their share of the economy;
• Energy is 5% of the ASX but negligible in the economy;
• Industrials are 60% less than their share of economic activity;
• Consumer discretionary is about two-thirds smaller than its share of activity; yet
• Consumer staples are about 20% larger; and
• Health care weighting is about 60% less than its share of the economy.

That misalignment of weightings is part of the answer to the often pondered but infrequently asked question about economic commentaries: “If you're so smart why aren't you rich?” If you can pick what is happening why can’t a fortune be made with that information?

Part of the answer lies in the fact that a lot of others also know the information. Haven’t you noticed how rare it is to find $100 notes lying in the street or inside your copy of the Australian Financial Review? It’s hard to get rich an easy way or when the information to get rich is widely known. Instead we try to understand what information is built into market prices and make assessments about it and how expectations of current issues may affect the outlook over time. GDP is not one of those; by the way it rose by 0.5% in the December quarter '” about 45% slower than the decade average.

CURVE TOO COOL FOR HIGHER RATES

One issue likely to affect the future is the Reserve Bank’s stance on interest rates. It has been pushing the line lately that “it is more likely that the next move in interest rates would be up rather than down”. That is at odds with what the free market part of the financial markets have priced in.

The Reserve is the monopolist setter of the official cash rate. Beyond a year or so, it has virtually no control on interest rates. In the free market, 10-year bonds still have a lower yield than the official cash rate. Contrary to the Reserve’s view, this suggests “that the next move in interest rates would [not] be up”.

More particularly, it suggests that if the Reserve ignores this and raises rates anyway (concerned that too many buyers are coming back into the housing market) then that would likely suppress GDP '” economic activity. Yet you wont read about that until many months from now; and by the way don’t expect that news to come with $100 notes inserted into those reports.

Dr Ron Woods is Challenger Financial Services' head of investment markets strategy