A country’s Gross Domestic Product (GDP) is commonly used as a measure of its economic productivity or output.
1. What is GDP?
The GDP is a key indicator to measure a country’s economic performance and growth over time.
GDP is the total value of all goods and services produced in a country within a period (usually annually or quarterly). For example, in 2022, Malaysia produced - in real terms1 - a total of RM1.5 trillion worth of goods and services (e.g. wholesale & retail services, electrical & electronic goods, etc.), with the real GDP growing by 8.7% from 2021.
Table 1: Malaysia’s GDP Growth Performance (2019 - 2022)
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2019
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2020
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2021
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2022
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Real GDP (RM' billion)
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1,424
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1,345
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1,387
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1,507
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Real GDP (% yoy)
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4.4%
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-5.5%
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3.1%
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8.7%
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Source: Department of Statistics Malaysia
2. How is GDP measured and computed?
The statistics department of a government is responsible for estimating the key components of GDP based on surveys and administrative sources. The most common method to compute GDP is the expenditure approach, which sums up consumer spending (C), corporate investments (I), government spending (G) as well as the exports and imports of a country.
As shown in the equation below, GDP represents the total expenditure of all these components:
Alternatively, GDP can also be computed using the output approach which sums up the total output produced by the key sectors of an economy (e.g. manufacturing, services, construction, mining, agriculture, etc.).
3. What do the components of GDP mean?
According to the expenditure approach, the various components of consumption, investment, government spending, exports and imports are defined as follows:
Table 2: GDP Components and Their Definitions
Components
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Definition
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Examples
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Consumption (C)
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The total value of all goods and services consumed by households in the country.
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Spending on goods (e.g. food, clothes and petrol) and services (e.g. financial, telecommunications and health services).
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Investment (I)
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The total value of all capital goods used in the country.
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Investment in machineries, equipment and construction structures.
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Government spending (G)
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The total value of all goods and services purchased by the government for public use.
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Spending and investments on roads, infrastructure repairs, national defence, schools and healthcare.
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Gross exports (X)
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Goods and services that are sold to other nations.
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Sales of electrical & electronics, oil & gas, food, chemical and other products to overseas countries.
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Gross imports (M)
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Spending on foreign goods and services by domestic residents (e.g. purchases of imported cars and holidays abroad).
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Purchases of food, chemical, electrical & electronics and other products from overseas countries.
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An example of the percentage change in Malaysia’s GDP and its components is shown in Table 3.
Table 3: Breakdown of Malaysia’s GDP Growth
Expenditure
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Share of GDP (%)
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Quarterly (%yoy)
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Yearly (%yoy)
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3Q22
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4Q22
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2021
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2022
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Private Consumption
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61
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15.1
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7.4
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1.9
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11.3
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Gov. Consumption
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13
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4.5
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2.4
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5.3
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3.9
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Fixed Investment
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19
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13.1
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8.8
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-0.9
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6.8
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Gross Exports
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74
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23.9
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9.6
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15.4
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12.8
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Gross Imports
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68
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24.4
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8.1
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17.7
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14.2
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GDP Growth
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100
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14.2
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7.0
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3.1
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8.7
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Among the GDP components, private consumption usually contributes around 40% to 60% of GDP for most countries.
4. How is GDP useful for investors?
For investors, GDP is useful as a key indicator of macroeconomic trends for the following reasons:
(i)
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To evaluate the prospects and momentum of corporate earnings
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For example, news of stronger-than-expected real GDP growth could encourage investors to be more optimistic over the prospects of listed companies’ earnings. As a result, they may take a more bullish position by increasing their investments.
On the other hand, the release of a weaker-than-expected real GDP growth data could dampen investors’ enthusiasm for stocks and, if the GDP print came in far lower than expectations, it could spark a sell-down in the stock market.
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(ii)
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To identify which segments of the economy are doing well
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As GDP is composed of the various components and sectors of an economy, the performance of these segments could provide investors with some insights into the companies engaged in those specific sectors.For example, a rise in consumption growth may be positive for stocks in the consumer sector, while a rise in exports could bode well for manufacturing companies that mainly exports to other countries.
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5. What are the limitations of GDP as an indicator of market performance?
While GDP is useful for investors, it has some limitations such as:
(a)
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GDP data is a lagging figure
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In general, stock markets are forward-looking as investors will buy or sell shares of companies depending on their expectations of the companies’ earnings prospects. Meanwhile, GDP data is released about one to two months after the end of the review period. For example, the fourth quarter of Malaysia’s GDP ending December 2022 was announced on 10 February 2023.
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(b)
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GDP is just one of many factors
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Apart from GDP data, other macro factors such the interest rate trends and the corporate earnings outlook may also impact the stock market’s performance.
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(c)
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GDP may not be fully represented by the companies in a stock market index
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For example, a broad equity market index such as Malaysia’s FTSE Bursa Malaysia KLCI comprises just 30 large-capitalisation companies. This market index does not fully reflect the country’s economic production capacity, especially the small and medium enterprises (SMEs). In Malaysia, SMEs account for an estimated 40% of the country’s GDP.
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Conclusion
Despite its limitations, the GDP remains an important indicator of a nation’s overall economic health as it provides some broad information on the progress and outlook for the nation’s economic performance and corporate earnings growth. Thus, it is essential that investors understand the basic concept of GDP and its components to better grasp the macroeconomic drivers of the financial markets which they invest in.
1Real GDP is an inflation-adjusted measure of an economy’s output. For example, if the value of 20 cars produced in one year is RM1 million, and that value increases to RM1.02 million with the same amount of cars produced in the following year, there isn’t really any growth in the output but just a change in price. In contrast, nominal GDP captures price changes over time. In the same example of an economy producing just cars, the nominal GDP would rise by 2%.
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