Stall Speed: The confusing math behind the GDP numbers
I’m not a pilot, but I’m told that stall speed is the minimum speed an airplane can go and maintain level flight. At this speed it can’t climb, but it won’t crash either. But if the plane goes any slower than this speed, it will descend.
One thing you may have seen in the headlines recently was that GDP (gross domestic product) was revised down to an annual rate of 2.7%. As a quick refresher, GDP, or gross domestic product, is the value of all goods and services produced in our country, as well as government spending. This number is in real terms, meaning this is the economy’s growth rate, after inflation.
But what does that really mean?
At first glance, 2.7% looks like a healthy number. For an advanced economy like ours, 3% growth is about as good as it gets. So, if we grew at a 2.7% clip last year, you’d probably think our economy was doing well. You’d conclude that we are definitely not at stall speed.
But looks can be deceiving.
It turns out that how the Bureau of Economic Analysis (BEA) arrives at this number is a little different than you would think. What they do is take the change from one quarter to the next, and then multiply it by four. Meaning that the economy actually grew 0.675% in the 4th quarter, and they multiplied it by four to get 2.7%.
The problem with doing that is that the economy didn’t grow by 0.675% each quarter last year. You might recall that the economy actually contracted the first two quarters.
To put this in perspective, last year, the stock market (SPDR S&P 500) had the following quarterly returns (for sake of the example I’m rounding and not including dividends):
- Quarter 1: -5%
- Quarter 2: -16%
- Quarter 3: -5%
- Quarter 4: +7%
If I was going to use the BEA’s math, the market was up an annualized 28% last year (7% X 4). Clearly, we all know that didn’t happen. I would be strung up if I calculated client returns like this.
How do we calculate returns for the stock market for last year? We compare the value of SPY on the last day of 2022 to the value of SPY on the last day of 2021. We do some math, and voila, the market returned -20% for the year. Quite a difference from +28%, right?
Now, I don’t believe there’s a conspiracy here. Because, in a negative quarter of growth, the BEA’s calculation method comes back to bite. But I do think it’s a very confusing way of doing things.
So, you ask, what’s the bottom line? When you calculate GDP like we do investment returns, the economy only grew 0.9% last year. That’s a big difference from 2.7%.
In my opinion, that’s stall speed. Anything goes wrong, and we’re in recession.