GDP stands for Gross Domestic Product, and represents the monetary value of all goods and services produced within a country over a specified period of time. GDP is how all countries grow and we track this through the business cycle.

This figure illustrates the typical business cycle:

gdp-business-cycle

The percentage change in real GDP is plotted on the vertical axis, and time is plotted on the horizontal axis. We can see how as real GDP rises and falls over time, the business cycle goes through expansionary peaks and recessionary troughs. We can also see that these short term oscillations occur, around an upward sloping secular or long term growth trend line.

To draw this business cycle, we have to be able to plot real GDP over time. Here is the basic approach most economic forecasters take to calculate GDP:

GDP = C + I + G + (X – M)

C = Consumption
I = Investment
G = Government Spending
(X – M) = Net Exports (the difference between imports and exports). If Imports > Exports Then a Country Runs a Trade Deficit

The four drivers of GDP growth include consumption, investment, government spending, and net exports. Where net exports represent the difference between the exports of a nation, and its imports. If imports exceed exports, a country is running a trade deficit.

At GuerillaStockTrading.com, I track what are called the leading economic indicators, that I use to try and predict movements in the business cycle.

gdp-leading-economic-indicators

For example, to track consumption, I may watch the Consumer Confidence report closely. The idea is that a more confident consumer will spend more, and therefore GDP growth will increase. Consumer confidence is considered to be a leading economic indicator of future growth.

Similarily to track investment, I may watch a leading economic indicator like the ISM Manufacturing Index. This is a broad and quite accurate measure of the health of the manufacturing sector, and a healthy ISM index with the value above 50, likely means an expanding economy.

I also pay very close attention to inflation by tracking the consumer price index or CPI. If this index shows inflation rising, the Federal Reserve might raise interest rates and thereby slow down GDP growth.

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